Estates and Trusts Permitted as Shareholders of an S Corporation

In this Analysis, Andrew W. Singer Esq. provides a review of the estates and trusts that qualify to be shareholders in an S Corporation. He writes:

     Subchapter S has from its inception allowed estates of deceased individual shareholders to be shareholders of S corporations. The term "estate" in this context was held to be "reasonably limited" to a period of time needed to accomplish the intended purpose of covering "the normal situation in which an individual has died and the consent of his estate is necessary to effect the election." Congress has since created an additional exception allowing an estate of an individual in a bankruptcy case under Chapter 11 of the United States Code to be an eligible shareholder, but in other respects the "estate" exception is presumably still limited to its original purpose.

Qualified Subpart E Trusts

     Under Subpart E, part I, Subchapter J, Chapter 1 of the Internal Revenue Code ("Subpart E"), income of a trust is taxable to the trust's grantor (and not to the trust or its beneficiaries under the rules normally applicable to the taxation of trust income under Subchapter J) if the grantor retains certain powers or interests in the trust that are described in IRC Sections 671-677. Income of a trust may also be taxable under Subpart E to a person other than the grantor if such person has the power to vest corpus or income in himself. In both cases, Subpart E treats the grantor (or a person other than the grantor) with prohibited powers or interests as the "owner" of the trust, or of that portion of the trust affected by the prohibited powers or interests.

     Where the income of a trust is taxable under Subpart E as if owned by a single individual (whether or not the grantor), and the individual is a citizen or resident of the United States, the trust becomes a Qualified Subpart E Trust which is permitted to hold stock in an S corporation as though it were a nominee of the individual who is the deemed owner of the stock. Thus, although the Code makes a Qualified Subpart E trust a permitted shareholder, it also provides that for purposes of IRC Section 1361(b)(1) (the eligibility requirements), the deemed owner is to be treated as the shareholder. Moreover, after the death of the deemed owner the former Qualified Subpart E Trust is permitted to continue holding S corporation stock without adversely affecting the S corporation's status for a period of up to 2 years beginning on the date of the deemed owner's death. During that 2-year period, the estate of the deemed owner is treated as the shareholder of the S corporation for purposes of IRC Section 1361(b)(1).

Qualified Subchapter S Trusts

     The Qualified Subchapter S Trust (hereafter "QSST") exception allows for the creation of a trust that will be treated as a Qualified Subpart E Trust, and therefore allowed to own stock in an S corporation, if it meets the definition of a QSST and the current income beneficiary of the trust elects to be treated as the "deemed owner" of the trust's S corporation stock under the Subpart E rules, even though the beneficiary does not actually possess the powers or interests that would make the trust's income from such stock taxable to the beneficiary under Subpart E.

(footnotes omitted)

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