Inadvertent-termination relief keeps S corporation status after an ineligible shareholder held the stock

Plain-English summary

An S corporation gets pass-through tax treatment only if all its shareholders are eligible; most partnerships and LLCs are not eligible shareholders. Here, an S corporation's stock was acquired by an LLC (taxed as a partnership), which automatically terminated the S election on that date. After the seller died, the LLC transferred the stock to a trust that could have qualified as an "electing small business trust" (ESBT), an eligible shareholder, but the trustee never filed the required ESBT election, so the S election would have terminated a second time even if it had survived the first. Section 1362(f) lets the IRS forgive an inadvertent termination if the lapse was not tax-motivated, the company took corrective steps after discovering it, and the company and shareholders agree to any adjustments the IRS requires. The IRS found the termination inadvertent and ruled that the company will keep being treated as an S corporation without interruption. The relief is conditioned on the trustee actually filing the ESBT election within 120 days of the letter, and the IRS expressed no opinion on whether the company or the trust are otherwise eligible.

Ruling snapshot

• Question: Was the termination of the S corporation election inadvertent under Section 1362(f), so the company keeps its S status?
• Outcome: approved (continuous S corporation treatment restored; contingent on filing the ESBT election within 120 days)
• Key authorities: IRC § 1362(f); IRC § 1361(b), (c), (e); Treas. Reg. § 1.1361-1(m)

Full text (IRS public release)

 Internal Revenue Service                                        Department of the Treasury
                                                                 Washington, DC 20224

 Number: 202504003                                               Third Party Communication: None
 Release Date: 1/24/2025                                         Date of Communication: Not Applicable
 Index Numbers: 1362.00-00, 1362.04-00
                                                                 Person To Contact:
 ----------------------------------                              ------------------------, ID No. -----------------
 ---------------------------------------------                   Telephone Number:
 ----------------------------                                    --------------------
 ----------------------------                                    Refer Reply To:
                                                                 CC:PSI:B3
                                                                 PLR-108299-24
                                                                 Date:
                                                                 October 25, 2024




LEGEND

X                =         -----------------------------------
                          -----------------------
State            =        -------------

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

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

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

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

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

B                =        -------------------------

C                =        --------------------

D                =        ---------------------

E                =        -----------------------

n                =        ---

LLC              =         ---------------------------------
                          -----------------------
Trust            =         -------------------------------------------
                          -----------------------
PLR-108299-24                                2

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

       This letter responds to a letter dated April 26, 2024, and subsequent
correspondence, submitted on behalf of X by its authorized representative, requesting a
ruling under § 1362(f) of the Internal Revenue Code (Code).

                                         FACTS

       The information submitted states that X, a State corporation, elected to be an S
corporation effective Date 1. On Date 2, LLC, a State limited liability company classified
as a partnership for federal tax purposes, acquired shares of X stock from A. A’s
grandchildren, B, C, D, and E, each own a n percent interest in LLC. Because LLC was
an ineligible shareholder under § 1361(b)(1)(B), X’s S corporation election terminated
on Date 2.

       Shortly after A died on Date 3, X learned that its S corporation election had
terminated on Date 2. Subsequently, on Date 4, LLC transferred its shares of X stock to
Trust. X represents that Trust is eligible to be an electing small business trust (ESBT)
under § 1361(e)(1) effective Date 4. However, the trustee(s) of Trust failed to make an
election under § 1361(e)(3) treating Trust as an ESBT effective Date 4. Consequently,
X’s S corporation election would have terminated on Date 4, had it not previously
terminated on Date 2.

       X represents that the circumstances resulting in the termination of its S
corporation election were inadvertent and were not the result of tax avoidance or
retroactive tax planning. X further represents that it has filed its federal tax returns
consistent with X being an S corporation effective Date 1. 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) states 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 taxable year.

       Section 1361(b)(1) provides that the term "small business corporation" means a
domestic corporation that is not an ineligible corporation and 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)(v) provides that, for purposes of § 1361(b)(1)(B), an ESBT
may be an S corporation shareholder.
PLR-108299-24                                 3

         Section 1361(e)(1)(A) provides that an ESBT 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), (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 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 all 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 1362(d)(2)(A) provides that an election under § 1362(a) shall 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) 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 § 1362(b)(2)) by reason of a failure to meet the requirements of
§ 1361(b) or to obtain shareholder consents or (B) was terminated under § 1362(d)(2)
or (3), (2) the Secretary determines that the circumstances resulting in the
ineffectiveness or termination were inadvertent, (3) no later than a reasonable period of
time after discovery of the circumstances resulting in the ineffectiveness or termination,
steps were taken (A) so that the corporation is a small business corporation or (B) to
acquire the shareholder consents, and (4) the corporation, and each person who was a
shareholder of the corporation at any time during the period specified pursuant to
§ 1362(f), agree to make such 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 in the ineffectiveness or
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 representations made, we conclude that
X’s S corporation election terminated on Date 2 when LLC, an ineligible S corporation
shareholder, acquired shares of X stock. We also conclude that had X’s S corporation
election not terminated on Date 2, it would have terminated on Date 4 as described in
PLR-108299-24                                4

this letter. We further conclude that the circumstances resulting in the termination of X’s
S corporation election were inadvertent within the meaning of § 1362(f). Therefore,
under § 1362(f), X will continue to be treated as an S corporation from Date 2, and
thereafter, provided X’s S corporation election was valid and has not otherwise
terminated under § 1362(d) for reasons not addressed in this letter.

        This ruling is contingent on the trustee(s) of Trust filing an ESBT election for
Trust effective Date 4 with the appropriate service center within 120 days from the date
of this letter and attaching a copy of this letter to the ESBT election.

         Except as specifically ruled above, we express or imply no opinion concerning
the federal tax consequences of the facts discussed or referenced in this letter under
any other provision of the Code. Specifically, we express or imply no opinion on X’s
eligibility to be an S corporation or Trust’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 requested ruling, 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 representative.


                                                 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
PLR-108299-24                                           5

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