S Corporation Trust Elections – IRS Leniency and Proper Planning


In a recently released IRS private letter ruling, an entity that elected to be treated as an S Corporation was granted relief for its inadvertent S Corporation termination. In the private letter ruling, two shareholders of the corporation, both trusts, failed to file Electing Small Business Trust (ESBT) elections under Section 1361 (e)(3) of the Internal Revenue Code.

IRS Leniency for Inadvertent Mistakes

The corporate taxpayer represented to the IRS that there was no tax avoidance or retroactive tax planning involved in the termination. Further, the circumstances resulting in the taxpayer’s ineffective S Corporation election were found to be inadvertent under Section 1362 (f) of the code. Thus, the IRS ruled that the corporate taxpayer was an S Corporation, provided its S Corporation election was otherwise valid and not otherwise terminated under Section 1362 (d) of the code.

WRVB attorneys handled a similar S Corporation trust election matter a few years ago. A corporation failed to file a Qualified Subchapter S Trust (QSST) election under Section 1361 (d)(2) of the code. In a subsequent IRS audit, the IRS proposed to terminate the corporation’s S election and assess a substantial tax and penalty amount.

We represented to the IRS at the National Office that there was no tax avoidance planning involved (indeed, there was no planning at all), and the failure to file the QSST election was inadvertent under the relief provisions of Section 1362 (f) of the code. The IRS abated the proposed tax and penalty assessment and determined the corporation was a valid S Corporation, provided it filed a proper, if late, QSST election.

Proper Planning for S Corp Elections

The lessons to be learned are twofold. First, the IRS has a lenient policy concerning failures to properly file S Corporation trust elections. Second, relying on the leniency of the Internal Revenue Service is not a good tax strategy.

If you are the owner, manager, or adviser of an S Corporation and you are considering placing some of the stock of the S Corporation in a trust, you need to engage the services of a tax professional with S Corporation trust experience. You do not want to be the one left standing without a chair when the IRS decides its leniency has reached its limits. Contact a member of WRVB’s tax practice if you have questions or concerns.


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