Missed ESBT elections caused an inadvertent S corporation termination

Plain-English summary

Shares of an S corporation were held through two trusts after an individual shareholder died. The trusts met the requirements for electing small business trusts, but their trustees did not timely make the ESBT elections, causing the corporation's S election to terminate when the trusts ceased to qualify under other permitted-shareholder rules. The IRS found that the termination was inadvertent under Section 1362(f) and allowed the corporation to continue being treated as an S corporation. The relief required the trustees to file ESBT elections for the specified effective dates and the trusts and beneficiaries to file any necessary amended returns within 120 days. Failure to meet those conditions would make the ruling null and void.

Ruling snapshot

• Question: Could the corporation retain S status after its shareholder trusts missed their ESBT elections?
• Outcome: approved
• Key authorities: IRC §§ 645, 1361, and 1362(f); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

Internal Revenue Service                                      Department of the Treasury
                                                              Washington, DC 20224

Number: 202413006                                             Third Party Communication: None
Release Date: 3/29/2024                                       Date of Communication: Not Applicable
Index Number: 1361.00-00, 1361.03-00,
              1361.03-03, 1362.00-00,                         Person To Contact:
              1362.02-00, 1362.04-00                          --------------------------, ID No. ----------------
                                                              -----------------
------------------------------                                Telephone Number:
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------------------------------------------                    Refer Reply To:
------------------------------                                CC:PSI:B01
-------------------------------                               PLR-113270-23
                                                              Date:
                                                              December 28, 2023




Legend

X             =       -------------------------------------------------------------------------------------------
                      ------------------------------

A             =       -------------------------

Trust 1       =       -------------------------------------------------------------------------------------------
                      ------------------------------

Trust 2       =       -------------------------------------------------------------------------------------------
                      ------------------------------

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

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

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

Date 4        =       -----------------------

Date 5        =       -------------------

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

PLR-113270-23                                 2


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

This letter responds to a letter dated June 14, 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

The information submitted states that X was incorporated on Date 1 under the laws of
State. X elected to be an S corporation effective Date 2. A, an individual, owned shares
of X stock through Trust 1 and Trust 2. Trust 1 and Trust 2 were eligible S corporation
shareholders under § 1361(c)(2)(A)(i). On Date 3, A died. After A’s death, Trust 1
elected under § 645 to be included in A’s estate. A’s estate was closed on Date 4.
Under § 1361(c)(2)(A)(ii), Trust 2 qualified as an eligible S corporation shareholder for
the two-year period beginning on the day the shares of X stock were transferred to it,
ending Date 5.

X represents that beginning on Date 3, both Trust 1 and Trust 2 met the requirements of
an Electing Small Business Trust (ESBT) within the meaning of § 1361(e)(1)(A).
However, the trustees of Trust 1 and Trust 2 did not make a timely election for Trust 1
or Trust 2 to be treated as ESBTs under § 1361(e)(3), thus causing X’s S corporation
election to terminate on Date 4.

X represents that there was no tax avoidance or retroactive tax planning involved in the
failure of Trust 1 or Trust 2 to file an ESBT election and the resulting termination of X’s
S corporation election. X and its shareholders agree to make any adjustments required
as a condition of obtaining relief under the inadvertent termination rule as provided
under § 1362(f) of the Code that 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 such year.

Section 1361(b)(1) provides that the term “small business corporation” means 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.

Section 1361(c)(2)(A)(iii) provides that, for purposes of § 1361(b)(1)(B), a trust with
respect to stock transferred to it pursuant to the terms of a will may be a shareholder,

PLR-113270-23                                 3

but only for the 2-year period beginning on the day on which such stock is transferred to
it.

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

Section 1361(e)(1)(A) provides that, for purposes of § 1361, except as provided in
§ 1361(e)(1)(B) , the term "electing small business trust" means 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)-(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 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
and subsequent taxable years of such trust unless revoked with the consent of the
Secretary.

Section 1.1361-1(m)(2)(i) of the Income Tax Regulations provides, in part, 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 ESBT election must be filed within the time
requirements prescribed in § 1.1361-1(j)(6)(iii) for filing a QSST election.

Section 1362(d)(2)(A) provides that an election under § 1362(a) shall be terminated
whenever (at any time on or after the 1st day of the 1st 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 not effective for the taxable year for which made (determined without
regard to § 1362(b)(2)) by reason of a failure to meet the requirements of § 1361(b) or
to obtain shareholder consents or was terminated under § 1362(d)(2), (2) the Secretary
determines that the circumstances resulting in such ineffectiveness or termination were
inadvertent, (3) no later than a reasonable period of time after discovery of the
circumstances resulting in such ineffectiveness or termination, steps were taken so that
the corporation for which the election was made or the termination occurred is a small
business corporation or to acquire the required shareholder consents, and (4) the
corporation for which the election was made or the termination occurred, and each

PLR-113270-23                                 4

person who was a shareholder in such corporation at any time during the period
specified pursuant to § 1362(f), agrees to make the adjustments (consistent with the
treatment of such corporation as an S corporation) as may be required by the Secretary
with respect to such period, then, notwithstanding the circumstances resulting in such
ineffectiveness or termination, such corporation shall be treated as an S corporation
during the period specified by the Secretary.

Section 645(a) provides that if both the executor (if any) of an estate and the trustee of
a qualified revocable trust elect the treatment provided in § 645, such trust shall be
treated and taxed as part of such estate (and not as a separate trust) for all taxable
years of the estate ending after the date of the decedent's death and before the
applicable date.

Section 645(b) provides that for purposes of § 645(a) the term ““applicable date” means
(A) if no return of tax imposed by chapter 11 of the Code is required to be filed, the date
which is 2 years after the date of the decedent's death, and (B) if such a return is
required to be filed, the date which is 6 months after the date of the final determination
of the liability for tax imposed by chapter 11 of the Code.

                                     CONCLUSION

Based solely on the facts submitted and representations made, we conclude that X's S
corporation election terminated on Date 4, because no ESBT election was filed for Trust

1. Additionally, we conclude that, had X's S corporation election not terminated on Date
4, X's S corporation election would have terminated on Date 5 because no ESBT
election was filed for Trust 2. Lastly, we conclude that the termination of X's S
corporation election on Date 4 was inadvertent within the meaning of § 1362(f).
Accordingly, X will be treated as an S corporation effective Date 4 and thereafter,
provided that X's S corporation election was otherwise valid and was not otherwise
terminated under § 1362(d).

This ruling in contingent upon the trustees of Trust 1 and Trust 2 filing an appropriately
completed ESBT election for Trust 1 and Trust 2 effective on Date 4 and Date 5,
respectively, and upon Trust 1, Trust 2, and their beneficiaries filing timely amended
federal income tax returns for all open years consistent with the treatment of Trust 1 and
Trust 2 as ESBTs effective Date 4 and Date 5, as necessary. The elections must be
made, and any amended returns must be timely filed, with the appropriate service
center within 120 days following the date of this letter, and a copy of this letter should be
attached to the returns. If these conditions are not met, this ruling is null and void.

Except as specifically ruled upon above, we express or imply no opinion concerning the
federal tax consequences of the facts of this case under any other provision of the
Code. Specifically, we express or imply no opinion regarding X’s eligibility to be an S
corporation or Trust 1’s or Trust 2’s eligibility to be an ESBT.

PLR-113270-23                                           5

This ruling is directed only to the taxpayer who requested it. According to § 6110(k)(3),
this ruling may not be used or cited as precedent.

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.

Pursuant to the power of attorney on file with this office, we are sending a copy of this
letter to X's authorized representative.


                                               Sincerely,




                                               _______________/s/________________
                                               Joy C. Spies
                                               Senior Technician Reviewer, Branch 1
                                               Office of the Associate Chief Counsel
                                               (Passthroughs & Special Industries)


Enclosure:
      Copy for § 6110 purposes

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