S corporation termination from missed ESBT election was inadvertent

Plain-English summary

Two spouses transferred their S corporation stock to a grantor trust. After one spouse died, the trust became a non-grantor trust and its trustees failed to make a timely electing small business trust election. The trust eventually became an ineligible shareholder, terminating the corporation's S election. The IRS ruled that the termination was inadvertent under IRC § 1362(f) and allowed the corporation to retain S status. Relief is conditioned on filing the ESBT election effective on the termination date and filing all required returns consistently within 120 days.

Ruling snapshot

• Question: May the corporation retain S status after its trust shareholder failed to make a timely ESBT election?
• Outcome: Approved, subject to corrective filings within 120 days
• Key authorities: IRC §§ 1361(c)(2), 1361(e), and 1362(f); Treas. Reg. § 1.1361-1(m)(2)(iii)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202520003 Third Party Communication: None
Release Date: 5/16/2025 Date of Communication: Not Applicable
Index Number: 1362.04-00
Person To Contact:
------------------------------ -----------------------------------, ID No. -------
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----------------------- Telephone Number:
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Refer Reply To:
CC:PT&E:B03
PLR-114682-24

                                                         Date:
                                                         February 14, 2025


                                              LEGEND

X = ------------------------------
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A = ------------------------

B = --------------------
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Trust = ----------------------------------------------------------------
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Date 1 = --------------------------

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

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

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

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

State = --------------------
PLR-114682-24 2

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

   This responds to a letter dated July 25, 2024 and subsequent communications,

submitted on behalf of X by X’s authorized representative, requesting relief under
section 1362(f) of the Internal Revenue Code.

                                      FACTS

    X was incorporated under the laws of State on Date 1. On Date 2, X elected to

be treated as an S corporation. On Date 3, X’s owners, spouses A and B, transferred
their stock in X to Trust. Trust was a grantor trust of A and B.

    On Date 4, A died and Trust became a non-grantor trust.

    X represents Trust was eligible to make an Electing Small Business Trust (ESBT)

election under § 1361(e)(3) effective Date 4. However, Trust’s trustee(s) failed to timely
make such election. The failure to make an ESBT election caused Trust to become an
ineligible shareholder of X, which caused X’s S election to terminate on Date 5.

   X represents it filed income tax returns consistent with having an S election for all

relevant tax periods. X represents that Trust has always met the requirements of an
ESBT within the meaning of § 1361(e), except that its trustees did not make a timely
ESBT election under § 1361(e)(3). It is represented that the failure to file an ESBT
election was inadvertent and not motivated by tax avoidance or retroactive tax planning.
X and each of its shareholders agree to make any adjustments required by the
Secretary as a condition of obtaining relief under the inadvertent termination rule as
provided under § 1362(f).

                              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) 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 1
class of stock.

   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 a
shareholder of an S corporation.
PLR-114682-24 3

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

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

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

small business trust (ESBT) may be an S corporation shareholder.

   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)(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(a) provides that a small business corporation may elect to be an S

corporation.

  Section 1362(d)(2) provides that an S corporation election 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(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 was terminated under § 1362(d)(2) or (3); (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 termination occurred is a small business corporation;
and (4) the corporation for which the election was made or termination occurred, and
each person who was a shareholder in such corporation at any time during the period
PLR-114682-24 4

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.

                                   CONCLUSION

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

X’s S corporation election terminated on Date 5 because Trust’s trustee(s) failed to
timely make an ESBT election under § 1361(e)(3). However, the termination of X’s S
corporation election was inadvertent within the meaning of § 1362(f). Accordingly, X
shall be treated as an S corporation from Date 5 and thereafter, provided its S
corporation election is not otherwise terminated under § 1362(d).

    This letter ruling is subject to the conditions that within 120 days from the date of

this letter (1) Trust’s trustee(s) file an ESBT election with respect to Trust effective Date
5, with the appropriate service center and (2) X and Trust file all required returns and
information returns (including amended returns) for all open years consistent with the
requested relief granted in this letter. A copy of this letter should be attached to the
ESBT election and any original or amended returns.

   If the above conditions are not met, then this ruling is null and void. Further, if

these conditions are not met, X must notify the service center with which it filed its S
corporation election that its election terminated on Date 5.

   Except as specifically ruled above, we express or imply no opinion concerning

the federal tax consequences of the facts described above under any other provision of
the Code and the regulations thereunder, including whether X was otherwise a valid S
corporation or whether Trust is a valid ESBT within the meaning of § 1361(e)(3).

   The ruling contained in this letter is based on 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 your authorized representative.
PLR-114682-24 5

                                          Sincerely,




                                          Richard T. Probst
                                          Senior Technician Reviewer, Branch 3
                                          Office of the Associate Chief Counsel
                                          (Partnerships, Trusts, and Estates)

Enclosures
Copy for § 6110 purposes

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