There are special rules that exist for trusts that hold shares or stocks in S corporations. In fact, there are only three types of trusts that may hold these assets:
- Grantor trusts
- Qualified subchapter S trusts (QSSTs)
- Electing small business trusts (ESBTs)
There are additional requirements each of these trusts must meet to hold stocks or shares in S corps. If the trust does not meet these requirements, the shareholders and the corporation itself could face serious consequences. To that end, seek the assistance of an experienced estate planning attorney to help ensure you transfer your S corporation stocks and shares into a trust properly and avoid unnecessary penalties.
Let’s take a closer look at each of these three types of trusts and the key considerations associated with each.
With a grantor trust, the person who creates the trust maintains interest in either the assets placed in the trust or the income the trust generates. The grantor is the trust owner on federal income tax returns, and so all losses and income go directly to that person. Grantor trusts may hold S corporation stock, regardless of the trust terms. The grantor does not need to make an election to be an S-corporation shareholder, so long as he or she is a U.S. resident or citizen.
Qualified Subchapter S Trusts (QSSTs)
The beneficiary of a QSST must join in making an S corporation election for tax purposes. A qualifying QSST must meet the following conditions:
- It only names one person to be the beneficiary of trust income, with the sole exception being that spouses can both be beneficiaries of the income if they file a joint federal income tax return and are both American residents or citizens.
- Only the beneficiary may take principal distributions from the QSST during his or her lifetime.
- The income beneficiary must receive all the trust income.
The person who creates the trust may add a stipulation stating that when the first income beneficiary dies, another beneficiary can take his or her place—so long as it continues to meet S corporation trust conditions.
Electing Small Business Trust (ESBT)
The ESBT is the only type of trust that may hold S corporation stock, have multiple beneficiaries and allow the trustee to maintain discretion regarding distributions. This is essentially a tax break from the IRS and the federal government, and so there are some strict guidelines in place for ESBTs. These include the following:
- All beneficiaries must be shareholders of the S corporation, and must also be a U.S. resident or citizen.
- The trustee must choose to have the trust considered a separate trust for income tax. It must be taxed at the highest income tax rate, separate from other assets.
For more information on how S corporation trusts work and the methods that are best for your specific circumstances, consult a knowledgeable California estate planning attorney.
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