Probate & Trust Law Section Conference Manual ... - Minnesota CLE

the discussion on this issue at Paragraph II(C)(3) of this outline
(“Addressing Valuation Discounts”).
5. Trust Provisions for S Corporations. While the income tax benefits of
flow-through reporting make S corporations attractive to many family
business owners, the various eligibility limitations add a layer of
complexity when drafting and administering trusts that will hold S
corporation stock. Only certain trusts are authorized to hold S corporation
stock. The most commonly used category is grantor trusts for income tax
purposes (e.g., revocable trusts). IRC § 1361(c)(2)(A)(i). Revocable
trusts and trusts under wills can also be S corporation shareholders for two
years after the death of the grantor. IRC § 1361(c)(2)(A)(ii), (iii). If these
provisions do not apply, then a trust may only hold S corporation stock if
it is a qualified subchapter S trust (QSST) or an electing small business
trust (ESBT).
a. QSST Trusts. Qualified subchapter S trust (QSST) provisions in a
trust can prevent an unintentional termination of S status, but they
can cause problems of their own. Among the requirements of a
QSST are that there may be only one income beneficiary and that
all the fiduciary accounting income of the trust must be distributed
each year. Further, any corpus distributed during the life of the
income beneficiary must be distributed to that beneficiary. If the
trust terminates during the life of the income beneficiary, all of the
trust's assets must be distributed to such beneficiary. These
limitations are usually contrary to the provisions clients would like
to see in their trusts – especially for young beneficiaries.
b. ESBT Trusts. Under IRC 1361(e)(1), a trust can qualify to hold S
stock as an electing small business trust (ESBT) even though it has
multiple beneficiaries and permits discretionary distributions of
income or corpus, as long as all the current beneficiaries of the
trust are permissible S corporation beneficiaries; no interest in the
trust was acquired by purchase; and the trust is not a QSST, a taxexempt
trust, or a charitable remainder trust. In determining
whether a trust may qualify as an ESBT, each potential current
beneficiary of the trust is treated as a shareholder, including for
counting purposes (i.e., the 75-shareholder limitation). A potential
current beneficiary includes any person who is entitled to, or at the
discretion of any person may receive, a distribution of trust
principal or income. Thus, for example, if any potential current
beneficiary of a trust is a nonresident alien, the trust will not
qualify as an ESBT. Appointees under powers of appointment are
considered potential current beneficiaries only if the power is
currently exercisable.
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