27 March
Posted by David M. Grant
Many people ask if a trust can own S Corporation stock.
In general, living trusts and testamentary trusts may hold S corporation stock only for two (2) years after the date of death of the grantor. After death, the trusts become ineligible shareholders and the corporation will lose its S-election due to the Grantor’s death.
While the grantor of a living trust is living, the Trust would be qualified as a “grantor trust” for income tax purposes, thus allowing all items of income and expense to flow through to the trust’s grantor. Upon death, the grantor trust status is switched off.
Qualified Subchapter S Trusts
At this point, only certain qualifying trusts may own subchapter S stock and still preserve the S election.
These are as follows: Qualified Subchapter S Trust (“QSST”). A QSST is a qualifying S corporation shareholder. In order for a trust to be a QSST it must meet the following requirements:
- There is only one income beneficiary and he or sheis a U.S. citizen or resident.
- All income of the trust is required to be distributed currently to the one income beneficiary.
- All corpus distributions must go to the one beneficiary.
- The beneficiary’s income interest must terminate at the earlier of the beneficiary’s death or trust’s termination.
- An election to be treated as an eligible S corporation shareholder must be made
If there is a successor beneficiary, the QSST election remains valid unless the new beneficiary affirmatively refuses to consent. A trust can have non-S assets and still qualify as a QSST, meaning part of the trust consisting of assetsother than the S corporation stock can be treated as a simple trust while the QSST portion of the trust will be treated similar to a grantor trust.
This type of situation requires a bifurcated type of trust income tax return. The trust return will report the income and deductions for all assets, excluding the S corp, and will separately report the S income and deductions in a pass-through way, similar to the way a grantor trust would be handled.
Electing Small Business Trust
Electing Small Business Trust (“ESBT”). An ESBT can have more than one beneficiary and the income can be either distributed or accumulated. This allows for a single trust to be created for the benefit of minor children, instead of requiring the creation of separate trusts for each child.
More importantly the trust can accumulate income rather than distributing substantial amounts of cash to a minor. In order to have the flexibility of an ESBT, the trust is taxed on the income related to the S corporation at the highest individual tax rate for ordinary income and 20% for long term capital gains. The ESBT can hold property other than the S corporation stock, in which case tax reporting is handled similarly to that of a QSST where the trust is bifurcated.
