Given the restrictions on the ownership of S-Corporation stock, it may be difficult for grantors to store such stock into a trust. However, upon proper election, the IRS regulations allow for two types of trusts to remedy this issue.
Qualified Subchapter S Trust (§ 1361(d))
The first such trust is the Qualified Subchapter S Trust (QSST). A QSST is a trust that requires only one beneficiary who must be a United States resident. The beneficiary is required to make the QSST election within 2.5 months of the trust receiving stock. A Sample QSST election form is included below.
Electing Small Business Trust (§ 1361(e))
The second type of trust is the Electing Small Business Trust (ESBT). An ESBT is a trust that allows for multiple beneficiaries, and the beneficiary can be an individual, estate or a charitable organization. The trustee is required to make the ESBT election within 2.5 months of the trust receiving stock.
Why the ESBT is better than the QSST
ESBTs are preferred over QSSTs for the simple reason that ESBTs are the more flexible option. QSSTs can only have one beneficiary that must be an individual. In addition, the children of the QSSTs beneficiary are barred from becoming beneficiaries. On the other hand, an ESBTs can have multiple beneficiaries including individuals, estates, and charitable organizations, and children of ESBT beneficiaries can become beneficiaries in the future.
It is worth noting that one must be careful when making such an election. Failure to make these elections in a timely manner may result in the corporation losing its Subchapter S status, which could impose the double tax under Subchapter C. Angering other shareholders this way is not a position that you want to be in.
SAMPLE QSST ELECTION
Internal Revenue Service Center
RE: QUALIFIED SUBCHAPTER S TRUST ELECTION
The current income beneficiary of the Trust hereby elects under IRC § 1361(d)(2) to treat the trust as a qualified Subchapter S trust pursuant to IRC § 1361(c)(2)(A)(i). The following information is provided:
Current Income Beneficiary:
Name
Address
Taxpayer identification number
Trust:
Name
Address
Taxpayer Identification Number
S Corporation:
Name
Address
Taxpayer Identification Number
This election is made under IRC § 1361(d)(2) to be effective as of [date] . On
[date] the stock of _____ was transferred to the ______ Trust, which meets all the requirements of Reg. § 1.1361 – 1(j)(6)(ii)( E)(1), (2), and (3) as follows:
- All trust income will be or is required to be distributed currently to one individual beneficiary who is a citizen or resident of the U.S.
- During the life of the current income beneficiary, there is only one income beneficiary of the trust.
- Any corpus distributed during the life of the current income beneficiary may be distributed only to that income beneficiary.
- The current income beneficiary’s income interest in the trust terminates on the earlier of that beneficiary’s death or the termination of the trust.
- If the trust terminates during the life of the current income beneficiary, the trust will distribute all of its assets to that income beneficiary.
- No distribution by the trust (income or corpus) will be in satisfaction of the grantor’s legal obligation to support the income beneficiary.
___________________ ________________ ___________
Signature of beneficiary Name of beneficiary Date
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