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

IRS Grants Relief for Overlooked ESBT Election, Saving S Corporation Status

The IRS granted relief under § 1362(f) to an S corporation whose election terminated after a trust failed to file a required Electing Small Business Trust (ESBT) election under § 1361(e), saving the company from potential tax liabilities and compliance adjustments. The termination occurred on Date 4 when shares held in Trust 1 were transferred to Trust 2, which was eligible to be an ESBT but never filed the election. The IRS ruled the termination was inadvertent and restored the S corporation status retroactively, contingent on Trust 2 filing a valid ESBT election.

The Question: Can Relief Be Granted for an Inadvertent Termination?

The taxpayer sought IRS relief under § 1362(f) after an S corporation election terminated due to Trust 2’s failure to file a required ESBT election under § 1361(e)(3). The termination occurred when shares transferred from Trust 1 to Trust 2 on Date 4, though Trust 2 was otherwise eligible to be an ESBT. The taxpayer argued the omission was unintentional and requested retroactive restoration of S corporation status without penalties.

The request relied on § 1362(f), which permits the IRS to waive an S election termination if the violation was inadvertent and the corporation corrects the issue promptly. The taxpayer emphasized the omission was not willful and that all parties were prepared to make necessary adjustments to resolve the issue.

The Facts: How a Missing Election Led to Termination

X, an LLC organized under State law, filed an S corporation election under § 1362(a) effective Date 2. On Date 2, shares were held by Trust 1, a grantor trust of A, which qualified as an eligible shareholder under § 1361(c)(2)(A)(ii). Upon A’s death on Date 3, Trust 1’s eligibility persisted, as grantor trusts retain shareholder status post-death.

On Date 4, shares transferred from Trust 1 to Trust 2, which was eligible to be an ESBT under § 1361(e). However, Trust 2’s trustee failed to file the required ESBT election under § 1361(e)(3), disqualifying it as a permissible shareholder under § 1361(b)(1)(B). This omission triggered X’s S corporation election termination under § 1362(d)(2)(A).

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

The IRS ruled that X’s S corporation election termination on Date 4 due to Trust 2’s failure to file an ESBT election was inadvertent under § 1362(f), as the omission was a procedural oversight rather than a willful act. The IRS found X met all relief conditions: (1) the termination was not willful, (2) X and its shareholders agreed to required adjustments, and (3) X committed to corrective actions.

To secure relief, Trust 2 must file a retroactive ESBT election effective Date 4. Trust 2 and its beneficiaries must file amended federal income tax returns for all open years within 120 days of the ruling letter’s date. X must submit a payment of $n to the IRS within 45 days of the ruling letter’s date, accompanied by a copy of the letter. Failure to meet these deadlines will void the ruling, reinstating X’s terminated S election.

Implications: What This Means for S Corporations and Trusts

The IRS’s decision to grant relief under § 1362(f) highlights the critical importance of timely ESBT elections. Trusts holding S corporation shares must file Form 8855 by the S corporation’s return due date to avoid disqualification, even for unintentional oversights. The IRS’s strict enforcement of deadlines leaves no room for ambiguity: compliance is mandatory.

Relief under § 1362(f) is available but contingent on proving the termination was inadvertent and taking prompt corrective action. Taxpayers must file amended returns and meet the 45-day payment deadline without exception. This underscores the IRS’s broader stance: relief is possible only with immediate, transparent compliance.

S corporations with ESBT shareholders should implement rigorous monitoring systems to track beneficiary eligibility, particularly for nonresident aliens, whose inclusion can trigger termination under § 1361(b)(1)(C). Failure to maintain these safeguards risks termination and loss of § 1362(f) relief if the IRS deems the error preventable.

Note: This ruling is non-precedential under § 6110(k)(3). While it may offer guidance, it does not bind future determinations. Taxpayers seeking similar relief must submit individual PLR requests or rely on Rev. Proc. 2022-19, which imposes strict conditions.