S corporation termination from missed ESBT elections treated as inadvertent

Plain-English summary

Two shareholders transferred S corporation stock to trusts that met the substantive requirements for electing small business trusts, but the trustees failed to file timely ESBT elections. That omission terminated the corporation's S election when the trusts became shareholders. The IRS found the termination inadvertent and allowed continuous S corporation treatment. Relief requires ESBT elections and any necessary consistent returns within 120 days, plus a specified payment within 45 days. If those conditions are not met, the ruling is void and the corporation must notify the service center that its S election terminated.

Ruling snapshot

• Question: May the corporation retain S status after two qualifying trusts inadvertently failed to file ESBT elections?
• Outcome: Approved, subject to elections, returns, and payment deadlines
• Key authorities: IRC §§ 1361(e) 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: 202521004 Third Party Communication: None
Release Date: 5/23/2025 Date of Communication: Not Applicable
Index Number: 1362.04-00, 1362.00-00,
1362.02-00, 1362.02-02, Person To Contact:
1362.03-00 -------------------------------, ID No. -----------
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--------------------------- Telephone Number:
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---------------------------------------- Refer Reply To:
------------------------- CC:PT&E:B03
-------------------------------- PLR-114588-24
Date:
February 14, 2025

                                                  LEGEND

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

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

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

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

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

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

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

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

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

n = ---------------

PLR-114588-24 2

Dear ---- -------- -

   This responds to a letter dated June 7, 2024, submitted on behalf of X by X’s

authorized representatives, requesting relief under section 1362(f) of the Internal
Revenue Code.

                                     FACTS

  The information submitted states that X was incorporated under the laws of State

on Date 1. X elected to be treated as an S corporation effective Date 2. On Date 3, A
and B transferred shares of X to Trust 1 and Trust 2.

   It is represented that Trust 1 and Trust 2 were eligible to make Electing Small

Business Trust (ESBT) elections under § 1361(e)(3), effective Date 3. However, the
trustees of Trust 1 and Trust 2 failed to make ESBT elections for the trusts to be eligible
S corporation shareholders; thus, Trust 1 and Trust 2 became ineligible shareholders of
X on Date 3. Accordingly, the failure to make ESBT elections caused X’s S election to
terminate on Date 3.

    X and its shareholders have filed all income tax returns consistent with having an

election to be treated as an S corporation for all taxable years since Date 2. Trust 1 and
Trust 2 have always met the ESBT requirements within the meaning of § 1361(e),
except that the trustees did not make a timely ESBT election under § 1361(e)(3). The
failure to file ESBT elections 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)(v) provides that, for purposes of § 1361(b)(1)(B), an

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

PLR-114588-24 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)(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) 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
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 3 because the trustees of Trust 1 and
Trust 2 failed to timely make ESBT elections under § 1361(e)(3). However, the
ineffectiveness 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 3 and

PLR-114588-24 4

thereafter, provided its S corporation election is not otherwise terminated under
§ 1362(d).

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

letter (1) the trustees of Trust 1 and Trust 2 file ESBT elections with respect to Trust 1
and Trust 2, effective Date 3 with the appropriate service center and (2) X and its
shareholders file any necessary original or amended returns consistent with the relief
granted in this letter. A copy of this letter should be attached to the ESBT elections and
any original or amended returns.

    Furthermore, as an adjustment under § 1362(f)(4), a payment of $n with a copy

of this letter within 45 days from the date of this letter must be sent to the following
address:

   Internal Revenue Service
   Kansas City Service Center
   333 W. Pershing Road
   Kansas City, MO 64108
   Stop 7777
   Attn: Manual Deposit

   If the above conditions are not met, then this ruling is null and void. Also, 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 3.

   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 1 and Trust 2 are valid ESBTs within the meaning of
§ 1361(e).

   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.

PLR-114588-24 5

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

copy of this letter to your authorized representative.

                                             Sincerely,


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

Enclosure:
Copy for § 6110 purposes

cc: -------------------------
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