Seven corporations received inadvertent S election relief for missed ESBT and QSST elections

Plain-English summary

Seven related corporations requested relief after several trusts failed to make timely electing small business trust (ESBT) and qualified subchapter S trust (QSST) elections. The missed elections caused four corporations' S elections to be ineffective and caused three other S elections to terminate, with additional later transfers creating further potential terminations. The corporations and trusts consistently filed as though the intended S, ESBT, and QSST elections were effective, and represented that the failures were inadvertent rather than tax-motivated. The IRS granted relief under Section 1362(f), allowing all seven corporations to be treated as S corporations during the affected periods. Relief was conditioned on the trustees and beneficiary filing the required ESBT and QSST elections within 120 days.

Ruling snapshot

• Question: Can seven corporations retain S corporation treatment after trusts failed to make timely ESBT and QSST elections?
• Outcome: approved, subject to filing the required trust elections within 120 days
• Key authorities: IRC §§ 1361(c), (d), (e), 1362(d), (f); Treas. Reg. § 1.1361-1(j), (m)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202431011                                              Third Party Communication: None
Release Date: 8/2/2024                                         Date of Communication: Not Applicable
Index Numbers: 1361.03-02, 1361.03-03,
              1362.04-00                                       Person To Contact:
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Trust 9 = ----------------------------------------------------------
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Trust 10 = ---------------------------------------------------------
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Date 9       = -------------------

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

       This letter is in response to your letter dated October 11, 2023, and subsequent
correspondence, submitted on behalf of State corporations, T, U, V, W, X, Y, and Z,
(Taxpayers), by their authorized representatives, requesting rulings under § 1362(f) of
the Internal Revenue Code (Code).

                                               Facts

       The information submitted states that each of T, U, X, Y, and Z elected to be an
S corporation effective Date 1, W elected to be an S corporation effective Date 2, and V
elected to be an S corporation effective Date 3.

       Each of Trust 1, Trust 2, Trust 3, and Trust 4 owned shares of T and Y on Date 1
and shares of V on Date 3. Trust 1 and Trust 2 also owned shares of U on Date 1. T,
V, and Y represent that Trust 1, Trust 2, Trust 3, and Trust 4 and U represents that
Trust 1 and Trust 2 were eligible to be electing small business trusts (ESBTs) under
§ 1361(e)(1). However, the trustee(s) of Trust 1, Trust 2, Trust 3, and Trust 4 failed to
make elections under § 1361(e)(3) treating Trust 1, Trust 2, Trust 3, and Trust 4 as
ESBTs effective Date 1. Consequently, each of T’s, U’s, and Y’s S corporation election
was ineffective on Date 1 and V’s S corporation election was ineffective on Date 3.

       On Date 4, shares of U were transferred to Trust 5 and Trust 6. U represents
that Trust 5 and Trust 6 were eligible to be ESBTs under § 1361(e)(1). However, the
trustee(s) of Trust 5 and Trust 6 failed to make elections under § 1361(e)(3) treating
Trust 5 and Trust 6 as ESBTs effective Date 4. Consequently, U’s S corporation
election would have terminated on Date 4, had it been effective.

        On Date 5, shares of X were transferred to Trust 5 and Trust 6, on Date 6,
shares of T, Y, and Z were transferred to Trust 5 and Trust 6, and on Date 11, shares of
V and W were transferred to Trust 5 and Trust 6. At the time of the transfers, Trust 5
and Trust 6 were ineligible S corporation shareholders because the trustee(s) of Trust 5
and Trust 6 failed to make elections under § 1361(e)(3) treating Trust 5 and Trust 6 as
ESBTs effective Date 4. Therefore, X’s S corporation election terminated on Date 5,
each of T’s and Y’s S corporation election would have terminated on Date 6 had it been
effective, Z’s S corporation election terminated on Date 6, and each of V’s and W’s S
corporation election would have terminated on Date 11, had V’s election been effective
or had W’s election not previously terminated.

       A, an individual, owned shares of T, V, W, X, Y, and Z, and shares of U through
Trust 7 and Trust 8. Each of Trust 7 and Trust 8 was treated under subpart E of part I
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of subchapter J of chapter 1 as entirely owned by A, and, thus, a permissible
shareholder under § 1361(c)(2)(A)(i). On Date 7, A died.

        On Date 8, pursuant to the terms of A's will, A's estate transferred shares of T,
W, X, Y, and Z to Trust 9 for the benefit of B and shares of V to Trust 10 for the benefit
of B. For a 2-year period beginning on Date 8, Trust 9 and Trust 10 were eligible S
corporation shareholders under § 1361(c)(2)(A)(iii). T, W, X, Y, and Z represent that
Trust 9 and V represents that Trust 10 were eligible to be qualified subchapter S trusts
(QSSTs) under § 1361(d) effective Date 9. However, B, the income beneficiary of Trust
9 and Trust 10 failed to make an election under § 1361(d)(2) to treat Trust 9 as a QSST
effective Date 9 with respect to each of T, W, X, Y, and Z and to treat Trust 10 as a
QSST effective Date 9 with respect to V. Consequently, W’s S corporation election
terminated on Date 9, and each of T’s, V’s, X’s, Y’s, and Z’s S corporation election
would have terminated on Date 9, had it been effective or not previously terminated.

Following the death of A, Trust 7 and Trust 8 continued to be eligible S corporation
shareholders for two years beginning on Date 7 under § 1361(c)(2)(A)(ii). U represents
that Trust 7 and Trust 8 were eligible to be ESBTs under § 1361(e)(1) effective Date 10.
However, the trustee(s) of Trust 7 and Trust 8 failed to make elections under
§ 1361(e)(3) treating Trust 7 and Trust 8 as ESBTs effective Date 10. Therefore, U’s S
corporation election would have terminated on Date 10, had it been effective or not
previously terminated.

       On Date 12, shares of X and Y were transferred to Trust 7 and Trust 8 and on
Date 13, shares of T, W and Z were transferred to Trust 7 and Trust 8. At the time of
the transfers, Trust 7 and Trust 8 were ineligible S corporation shareholders, because
the trustee(s) of Trust 7 and Trust 8 failed to make elections under § 1361(e)(3) treating
Trust 7 and Trust 8 as ESBTs effective Date 10. Consequently, each of X’s and Y’s S
corporation election would have terminated on Date 12, had X’s election not previously
terminated and had Y’s election been effective or not previously terminated, and each of
T’s, W’s, and Z’s S corporation election would have terminated on Date 13, had T’s
election been effective or not previously terminated and had each of W’s and Z’s
election not previously terminated.

       T, U, V, and Y represent that the circumstances resulting in their ineffective S
corporation elections and W, X, and Z represent that the circumstances resulting in the
termination of their S corporation elections were inadvertent and were not motivated by
tax avoidance or retroactive tax planning. Additionally, Taxpayers represent that
(1) they have filed all of their federal tax returns consistent with being S corporations,
(2) Trust 1 through Trust 4 have filed consistently as ESBTs effective Date 1, (3) Trust 5
and Trust 6 have filed consistently as ESBTs effective Date 4, (4) Trust 7 and Trust 8
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have filed consistently as ESBTs effective Date 10, and (5) Trust 9 and Trust 10 have
filed consistently as QSSTs effective Date 9. Finally, Taxpayers and their shareholders
agree to make any adjustments (consistent with the treatment of Taxpayers as S
corporations) 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 such year.

       Section 1361(b)(1)(B) provides that the term “small business corporation” means
a domestic corporation that is not an ineligible corporation and which does not, among
other requirements, 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.

       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) 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(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 an S
corporation shareholder, 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
may be an S corporation shareholder.

        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
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(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) provides that, for purposes of § 1361, the term “qualified
subchapter S trust” means 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(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(j)(6)(i) of the Income Tax Regulations provides, in part, that a
QSST election must be made separately with respect to each corporation whose stock
is held by the trust.

        Section 1.1361-1(j)(6)(ii) provides that the current income beneficiary of a QSST
must make the election by signing and filing with the service center for which the S
corporation files its income tax return, the applicable form or a statement that includes
the information listed in § 1.1361-1(j)(6)(ii).


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        Section 1.361-1(j)(6)(iii) provides, in part, that a QSST election must be filed
within the time requirements of § 1.1361-1(j)(6)(iii)(A) through (D).

       Section 1.1361-1(m)(2)(i) provides, in part, that the trustee of an ESBT must
make the ESBT election by signing and filing, with the service center for which the S
corporation files its income tax return, a statement that meets the requirements of
§ 1.1361-1(m)(2)(ii). Generally, only one ESBT election is made for the trust,
regardless of the number of S corporations whose stock is held by the ESBT.

       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 1.1361-1(m)(2)(iv) provides that a trust that is a qualified S corporation
shareholder under § 1361(c)(2)(A)(ii) or (iii) may elect ESBT treatment at any time
during the 2-year period described in those sections or the 16-day and 2-month period
beginning on the date after the end of the 2-year period.

      Section 1362(a) provides that, except as provided in § 1362(g), a small business
corporation may elect, in accordance with the provisions of § 1362, to be an S
corporation.

        Section 1362(d)(2)(A) provides that an election under § 1362(a) is 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 part, that if (1) an election under § 1362(a) by any
corporation (A) was not effective for the taxable year for which made (determined
without regard to § 1361(b)(2)) by reason of failure to meet the requirements of
§ 1361(b), or (B) 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, and (4) the corporation for which the election was made or the termination
occurred, and each person who was a shareholder of the corporation at any time during
the period specified pursuant to § 1362(f), agree to make the adjustments (consistent
with the treatment of the corporation as an S corporation) as may be required by the
Secretary with respect to such period, then, notwithstanding the circumstances resulting


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in such ineffectiveness or termination, the corporation shall 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 (1) each of T’s, U’s, and Y's S corporation election was ineffective on Date 1 and
V’s S corporation election was ineffective on Date 3 when the trustee(s) of Trust 1, Trust
2, Trust 3, and Trust 4 failed to make an ESBT election for each of Trust 1, Trust 2,
Trust 3, and Trust 4 effective Date 1, (2) X’s S corporation election terminated on Date 5
when shares of X were transferred to Trust 5 and Trust 6, ineligible S corporation
shareholders, (3) Z’s S corporation election terminated on Date 6 when shares of Z
were transferred to Trust 5 and Trust 6, ineligible S corporation shareholders, and
(4) W’s S corporation election terminated on Date 9 when B, the income beneficiary of
Trust 9, failed to make a QSST election effective Date 9 with respect to W. We also
conclude that had each of T’s, U’s, V’s, and Y’s S corporation election been effective
and had each of X’s, Z’s, and W’s S corporation election not terminated on Date 5, Date
6, and Date 9, respectively, each election would have subsequently terminated as
described in this letter. Further, we conclude that the circumstances resulting in the
ineffectiveness of each of T’s, U’s, V’s, and Y’s S corporation election and in the
termination of each of X’s, Z’s, and W’s S corporation election were inadvertent within
the meaning of § 1362(f). Therefore, under § 1362(f), (1) each of T, U, and Y will be
treated as an S corporation from Date 1 and thereafter, provided each of T’s, U’s, and
Y’s S corporation election was otherwise valid and has not otherwise terminated
under § 1362(d) for reasons not addressed in this letter, (2) V will be treated as an S
corporation from Date 3 and thereafter, provided that V's S corporation election was
otherwise valid and has not otherwise terminated under § 1362(d) for reasons not
addressed in this letter, and (3) each of X, Z, and W will continue to be treated as an S
corporation from Date 5, Date 6, and Date 9, respectively, provided that each of X’s,
Z’s, and W’s S corporation election was valid and has not otherwise terminated under
§ 1362(d) for reasons not addressed in this letter.

        These rulings are conditioned on: (1) the trustee(s) of Trust 1, Trust 2, Trust 3,
and Trust 4 filing an ESBT election for each of Trust 1, Trust 2, Trust 3, and Trust 4
effective Date 1, (2) the trustee(s) of Trust 5 and Trust 6 filing an ESBT election for each
of Trust 5 and Trust 6 effective Date 4, (3) the trustee(s) of Trust 7 and Trust 8 filing an
ESBT election for each of Trust 7 and Trust 8 effective Date 10, (4) B filing a QSST
election for Trust 9 effective Date 9 with respect to each of T, W, X, Y, and Z, and (5) B
filing a QSST election for Trust 10 effective Date 9 with respect to V. The elections
must be made with the appropriate service center within 120 days from the date of this
letter and a copy of this letter should be attached to each ESBT and QSST election.
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         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 (i) Taxpayers’
eligibility to be S corporations, (ii) each of Trust 1’s through Trust 8’s eligibility to be an
ESBT, or (iii) each of Trust 9’s and Trust 10’s eligibility to be a QSST.

      The rulings contained in this letter are based upon information and
representations submitted by the taxpayers 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 requested rulings, it is subject to verification on
examination.

      These rulings are directed only to the taxpayers requesting them. Section
6110(k)(3) of the Code provides that they 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 Taxpayers’ authorized representatives.



                                       Sincerely,



                                       Mary Beth Carchia
                                       Senior Technician Reviewer, Branch 3
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)




Enclosure:
      Copy of this letter for § 6110 purposes




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