Late ESBT election did not end S corporation status

Plain-English summary

Shares of an S corporation passed under a shareholder's will to a trust for one income beneficiary, who elected qualified subchapter S trust treatment. When the beneficiary died, the trust stopped qualifying as a QSST but remained an eligible S corporation shareholder for two years. The trust then became ineligible because its trustee did not timely elect electing small business trust treatment, terminating the corporation's S election. The corporation represented that the mistake was inadvertent, was not motivated by tax avoidance or retroactive planning, and that the parties consistently filed as if S status and ESBT treatment continued. The IRS granted inadvertent-termination relief under section 1362(f) and treated the corporation as continuing to be an S corporation. Relief was conditioned on the trustee filing a retroactive ESBT election within 120 days.

Ruling snapshot

• Question: Was the S corporation's termination caused by the trust's late ESBT election inadvertent under IRC § 1362(f)?
• Outcome: Approved, conditioned on a retroactive ESBT election within 120 days
• Key authorities: IRC §§ 1361(c), 1361(d), 1361(e), and 1362(f); Treas. Reg. § 1.1361-1(j) and (m)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202349005 Third Party Communication: None
Release Date: 12/8/2023 Date of Communication: Not Applicable
Index Number: 1362.00-00, 1362.01-00,
1362.04-00 Person To Contact:
-----------------------, ID No. -----------------
------------------------ Telephone Number:
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--------------------- Refer Reply To:
--------------------------- CC:PSI:3
------------------------------------ PLR-105557-23
Date:
September 13, 2023

Legend:

X = -------------------------------------------------------------------------
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Date 1 = -----------------

Date 2 = ------------------

Date 3 = ------------------

State = -------------

QTIP = -------------------------------------------------------------------------
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Estate = -------------------------------------------------------------------------
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A = ---------------------------

B = ----------------------------
PLR-105557-23 2

Dear ------------------:

    This letter responds to a letter dated March 7, 2023, and subsequent

correspondence, submitted on behalf of X by its authorized representatives, requesting
a ruling under § 1362(f) of the Internal Revenue Code (Code).

                                     FACTS

    According to the information submitted, X was incorporated under the laws of

State and elected to be an S corporation effective Date 1. A, a shareholder of X, died
and pursuant to A’s will shares of X stock were transferred to QTIP for the benefit of B.
B, the sole income beneficiary of QTIP, elected to treat QTIP as a qualified subchapter
S trust (QSST) under § 1361(d)(2).

    On Date 2, B died and QTIP ceased to qualify as a QSST. Estate assumed B’s

interest in QTIP and Estate was treated as a shareholder of X. QTIP remained an
eligible S corporation shareholder for two years, until Date 3, at which time QTIP
became an ineligible S corporation shareholder of X, thereby causing X’s S corporation
election to terminate on Date 3. X represents that QTIP has at all times since Date 2
met the requirements of an electing small business trust (ESBT) within the meaning of
§ 1361(e)(1)(A), but the trustee of QTIP failed to timely file an election under
§ 1361(e)(3) to treat QTIP as an ESBT.

    X represents that the circumstances resulting in the termination of its

S corporation election were inadvertent and were not motivated by tax avoidance or
retroactive tax planning. Further, X represents that it and its shareholders have always
filed tax returns consistent with X being an S corporation, and QTIP being an ESBT
effective Date 3. Finally, X and its shareholders agree to make any adjustments
consistent with the treatment of X as an S corporation as may be required by the
Secretary.

                              LAW AND ANALYSIS

    Section 1361(a)(1) provides that the term “S corporation” means, with respect to

any taxable year, a small business corporation for which an election under § 1362(a) is
in effect for the year.

   Section 1361(b)(1) defines a “small business corporation” as a domestic

corporation which is not an ineligible corporation and which does not (A) have more
than 100 shareholders, (B) have as a shareholder a person (other than an estate, a
trust described in § 1361(c)(2), or an organization described in § 1361(c)(6)) who is not
an individual, (C) have a nonresident alien as a shareholder, and (D) have more than
one class of stock.
PLR-105557-23 3

   Section 1361(c)(2)(A)(i) provides that, for purposes of § 1361(b)(1)(B), a trust all

of which is treated (under subpart E of part I of subchapter J of chapter 1 of the Code)
as owned by an individual who is a citizen or resident of the United States may be an S
corporation shareholder.

   Section 1361(c)(2)(A)(ii) provides that for purposes of § 1361(b)(1)(B), a trust

which was described in § 1361(c)(2)(A)(i) immediately before the death of the deemed
owner and which continues in existence after such death may be an S corporation
shareholder, but only for the 2-year period beginning on the day of the deemed owner’s
death.

    Section 1361(d)(1) provides that in the case of a QSST with respect to which a

beneficiary makes an election under § 1361(d)(2) — (A) such trust shall be treated as a
trust described in § 1361(c)(2)(A)(i), (B) for purposes of § 678(a), the beneficiary of such
trust shall be treated as the owner of that portion of the trust which consists of stock in
an S corporation with respect to which the election under § 1361(d)(2) is made, and (C)
for purposes of applying §§ 465 and 469 to the beneficiary of the trust, the disposition of
the S corporation stock by the trust shall be treated as a disposition by such beneficiary.

  Section 1361(d)(2) provides that a beneficiary of a QSST (or his legal

representative) may elect to have § 1361(d) apply.

     Section 1361(d)(3) defines a QSST as a trust, (A) the terms of which require that

(i) during the life of the current income beneficiary, there shall be only one income
beneficiary of the trust, (ii) any corpus distributed during the life of the current income
beneficiary may be distributed only to such beneficiary, (iii) the income interest of the
current income beneficiary in the trust shall terminate on the earlier of such beneficiary’s
death or the termination of the trust, and (iv) upon the termination of the trust during the
life of the current income beneficiary, the trust shall distribute all of its assets to such
beneficiary, and (B) all of the income (within the meaning of § 643(b)) of which is
distributed (or required to be distributed) currently to one individual who is a citizen or
resident of the United States.

  Section 1361(c)(2)(A)(v) provides that, for purposes of § 1361(b)(1)(B), an ESBT

may be an S corporation shareholder.

   Section 1361(e)(1)(A) defines an ESBT as any trust if (i) such trust does not have

as a beneficiary any person other than (I) an individual, (II) an estate, (III) an
organization described in § 170(c)(2), (3), (4), or (5), or (IV) an organization described in
§ 170(c)(1) which holds a contingent interest in such trust and is not a potential current
beneficiary, (ii) no interest in such a trust was acquired by purchase, and (iii) an election
under § 1361(e) applies to such trust.

   Section 1361(e)(3) provides that an election under § 1361(e) shall be made by

the trustee. Any such election shall apply to the taxable year of the trust for which made
PLR-105557-23 4

and all subsequent taxable years of such trust unless revoked with the consent of the
Secretary.

    Section 1.1361-1(j)(7)(ii) of the Income Tax Regulations provides that if, upon the

death of the QSST income beneficiary, the trust continues in existence and continues to
hold S corporation stock but no longer satisfies the QSST requirements, is not a grantor
trust or an ESBT, then, solely for purposes of § 1361(b)(1), as of the date of the income
beneficiary’s death, the estate of that income beneficiary is treated as the shareholder
of the S corporation for 2 years or until the transfer of the stock by the trust.

    Section 1.1361-1(m)(2)(i) provides that the trustee of an ESBT must make the

ESBT election by signing and filing, with the service center where the S corporation files
its income tax return, a statement that meets the requirements of § 1.1361-1(m)(2)(ii).

   Section 1.1361-1(m)(2)(iii) provides that the trustee of an ESBT must file the

ESBT election within the time requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a
QSST election (generally within the 16-day-and-2-month period beginning on the day
that the stock is transferred to the trust).

   Section 1362(d)(2)(A) provides that an election under § 1362(a) will be

terminated whenever (at any time on or after the first day of the first taxable year for
which the corporation is an S corporation) such corporation ceases to be a small
business corporation. Section 1362(d)(2)(B) provides that any termination under
§ 1362(d)(2)(A) is effective on and after the date of cessation.

    Section 1362(f) provides, in relevant part, that if (1) an election under § 1362(a)

by any corporation was terminated under § 1362(d)(2) or (3), (2) the Secretary
determines that the circumstances resulting in such termination were inadvertent, (3) no
later than a reasonable period of time after discovery of the circumstances resulting in
the termination, steps were taken so that the corporation for which the termination
occurred is once more a small business corporation, and (4) the corporation for which
the termination occurred and each person who was a shareholder in the corporation at
any time during the period specified pursuant to § 1362(f), agrees to make adjustments
(consistent with the treatment of the corporation as an S corporation) as may be
required by the Secretary with respect to the period, then, notwithstanding the
circumstances resulting in the termination, the corporation will be treated as an S
corporation during the period specified by the Secretary.

                                  CONCLUSION

    Based solely on the facts submitted and the representations made, we conclude

that X’s S corporation election terminated on Date 3 when QTIP became an ineligible
shareholder. We also conclude that the circumstances resulting in the termination of
X’s S corporation election were inadvertent within the meaning of § 1362(f). Therefore,
X will be treated as continuing to be an S corporation from Date 3 and thereafter,
PLR-105557-23 5

provided that X’s S election was otherwise valid and was not otherwise terminated
under § 1362(d).

    This ruling is conditioned on the trustee of QTIP filing an ESBT election for QTIP,

effective Date 3, with the appropriate service center within 120 days from the date of
this letter. A copy of this letter should be attached to the ESBT election.

     Except as expressly provided herein, we express or imply no opinion concerning

the tax consequences of any aspect of any transaction or item discussed or referenced
in this letter. Specifically, we express or imply no opinion regarding X’s eligibility to be
an S corporation or QTIP’s eligibility to be an ESBT.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.

  In accordance with a power of attorney on file with this office, we are sending a

copy of this letter to X's authorized representatives.

                                   Sincerely,



                                   Robert D. Alinsky
                                   Branch Chief, Branch 3
                                   Office of Associate Chief Counsel
                                   (Passthroughs & Special Industries)

Enclosure:
Copy of letter for § 6110 purposes
PLR-105557-23 6

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