IRS Grants Relief for Inadvertent Termination of S Corporation Election Due to Missing ESBT Election

The IRS granted relief under § 1362(f) to an S corporation whose election terminated after failing to file an Electing Small Business Trust (ESBT) election under § 1361(e)(3). The taxpayer requested relief after its S election lapsed due to the trust’s missed Form 8855 filing, and the IRS approved the request on the condition that the ESBT election be filed retroactively and a specified fee be paid. This ruling underscores the IRS’s willingness to grant relief for inadvertent errors, provided taxpayers act promptly to correct them.

The Question: Can an S Corporation Regain Its Status After an Inadvertent Termination?

The taxpayer, an S corporation, faced an inadvertent termination of its election after its sole shareholder—a trust—failed to file a required Electing Small Business Trust (ESBT) election under § 1361(e)(3). The legal question presented to the IRS was whether the corporation could regain its S status under § 1362(f), which provides relief for inadvertent terminations, despite the missed filing. The taxpayer argued that the termination was unintentional, as the trust had always met ESBT requirements except for the untimely Form 8855 filing, and that all tax returns had been filed consistently with the S election remaining in effect.

The Facts: How a Missing Election Led to Termination

X was incorporated under State law on Date 1, and on the same day, the Trust acquired 100% of X’s shares. On Date 1, X elected to be treated as an S corporation under § 1362(a), which permits corporations meeting certain requirements to pass income, losses, deductions, and credits through to shareholders.

The Trust was eligible to make an Electing Small Business Trust (ESBT) election under § 1361(e)(3), a provision allowing certain trusts to hold S corporation stock without terminating the election. However, the trustees of the Trust failed to file Form 8855, the required election document, within the statutory deadline. Because the Trust did not make a timely ESBT election, it was treated as an ineligible shareholder under § 1361(c)(2). Under § 1362(d)(2), an S corporation’s election terminates if it has an ineligible shareholder.

As a result, X’s S election terminated on Date 2, retroactive to the date the Trust acquired the shares. Despite the termination, X and the Trust consistently treated X as an S corporation in all income tax filings for all taxable years since Date 1, reflecting the corporation’s ongoing operations under S status.

The Ruling: IRS Grants Relief Under § 1362(f) with Conditions

The IRS confirmed that X’s S election terminated on Date 2 because the trustees of the Trust failed to timely file an ESBT election under § 1361(e)(3). Under § 1362(d)(2), the corporation’s S election terminated retroactive to the date the Trust acquired the shares, as the Trust was treated as an ineligible shareholder under § 1361(c)(2).

However, the IRS determined the termination was inadvertent within the meaning of § 1362(f). Accordingly, X is treated as an S corporation from Date 2 onward, provided its S election does not otherwise terminate under § 1362(d). This relief is contingent on three conditions:

First, the trustees of the Trust must file an ESBT election (Form 8855) within 120 days of this ruling, effective Date 2, with the appropriate IRS service center. Second, X, its shareholder, and the Trust’s trustees must file any necessary original or amended returns consistent with this relief, attaching a copy of this letter to those filings. Third, X must pay an adjustment amount of $n within 45 days of this ruling, sending the payment and a copy of this letter to the IRS Kansas City Service Center.

Failure to meet these conditions renders this ruling null and void. If the conditions are not satisfied, X must notify the IRS service center with which it filed its S election.

The Rationale: Why the IRS Granted Relief for an Inadvertent Error

The IRS granted relief under § 1362(f), which permits an S corporation’s election to remain effective despite an inadvertent termination if specific conditions are met. Section 1362(f) requires that the termination result from circumstances beyond the corporation’s control, that the corporation act promptly to correct the issue, and that all affected parties agree to any required adjustments. In this case, the IRS determined that X’s termination of its S election was inadvertent because the trustees of Trust failed to file a timely Electing Small Business Trust (ESBT) election under § 1361(e)(3), despite Trust otherwise meeting ESBT requirements.

The IRS found that X’s situation satisfied all three prongs of § 1362(f). First, the failure to file the ESBT election was inadvertent, as it was not motivated by tax avoidance or retroactive planning. Second, X and Trust acted promptly to seek relief, filing their request within a reasonable period after discovering the error. Third, X and its shareholder agreed to make all necessary adjustments, including filing amended returns and paying the required adjustment amount, as outlined in the ruling’s conditions.

The IRS’s review was limited to the facts submitted and representations made, and the ruling is non-precedential, meaning it cannot be cited as precedent for other taxpayers. The IRS emphasized that relief is granted solely based on the specific circumstances presented, reinforcing the importance of strict compliance with S corporation eligibility rules moving forward.

Implications: What This Ruling Means for S Corporations and Trusts

This ruling underscores the IRS’s pragmatic approach to inadvertent S corporation terminations, signaling a willingness to grant relief under § 1362(f) when taxpayers act swiftly to correct errors. For S corporations, the decision serves as a cautionary tale: even minor administrative oversights—such as a missed Electing Small Business Trust (ESBT) election—can trigger termination, but timely remediation may preserve status. The IRS’s conditional relief (requiring corrective filings and payments) demonstrates that proactive correction, rather than retroactive tax planning, is the path to reinstatement.

For trusts, the ruling is a stark reminder of the strict filing deadlines for ESBT elections under § 1361(e)(3). Trustees must file Form 8855 within 2 months and 15 days of acquiring S corporation stock or risk jeopardizing the corporation’s tax status. The IRS’s willingness to grant relief in this case does not diminish the need for meticulous compliance, as future inadvertent errors may not receive the same leniency.

Practitioners bear heightened responsibility to audit shareholder structures and trust elections. The ruling highlights the necessity of verifying that all ESBT, QSST, or other shareholder elections are filed correctly and documented, particularly in estate planning or corporate restructuring scenarios. When errors occur, practitioners must prepare to demonstrate inadvertence and reasonable cause to the IRS, including evidence of prompt corrective action.

Finally, taxpayers should heed the IRS’s reminder that this ruling is non-precedential under § 6110(k)(3). While it provides insight into the IRS’s current interpretation, it cannot be cited as precedent for other cases. Strict adherence to S corporation eligibility rules remains the surest safeguard against termination.