People establish trusts to hold property and help their loved ones avoid the probate process after they pass away. Businesses are often a type of property that people are particularly worried about protecting after they are gone. If a business is subject to the probate process, it may also be open to creditor claims and other negative elements that can deplete the property within an estate.
It is possible to place an S corporation into a trust, but there are certain types of trusts that may be better than others for this purpose. There are also certain tax implications associated with holding S corporation stocks in a trust. Below, our Nevada trusts lawyer explains more.
What is an S Corporation?
S corporations are corporations within the United States that do not have:
- More than 100 shareholders
- Ineligible shareholders, such as shareholders who have not been approved by the Board of Directors
- More than one type of stock
S corporations are pass-through entities in which all credits, income, and deductions flow through the entity to the shareholders on a pro rata basis.
Using a Trust to Hold an S Corporation Stock
Grantor trusts can hold stocks in S corporations as long as the grantor qualifies as a shareholder of the corporation. Non-grantor trusts, in which the grantor has relinquished control of the property within the trust after establishing it, are not generally eligible unless the Tax Code expressly permits it. There are two options available for non-grantor trusts to be eligible as an S corporation shareholder. These are as follows:
- They qualify as a subchapter S trust
- They qualify as an electing small business trust
There are still challenges to overcome when qualifying under the two above options. Qualifying under the above option may also interfere with the grantor’s purpose of establishing the trust.
Qualified Subchapter S Trust (QSST)
To be eligible as a QSST, the trust must meet certain requirements. The first is that there must be just one beneficiary to income and principal and the beneficiary must receive the income every year. The beneficiary of the trust must also choose to be treated as the owner of the portion of the trust that contains the S stock.
The other requirement to fulfill is that the beneficiary of the trust must be treated as the owner of the portion of the trust that is related to the S corporation stock. If a trust qualifies as a QSST, the non-grantor treatment is invalidated with regards to the S corporation stock. If the grantor wishes the trustee to be able to accumulate income within the trust, the rules for a QSST do not allow this.
Electing Small Business Trust (EBST)
The requirements for an EBST do provide more flexibility than QSST trusts. For example, trustees can accumulate income using an EBST, but there are some tax drawbacks that can become very expensive. The trustee makes the EBST selection instead of the beneficiaries, under the Tax Code. An eligible EBST also allows multiple beneficiaries of the trust, unlike QSST trusts that only permit one beneficiary.
However, the tax impacts of an EBST have more negative consequences. The higher income tax burden is due to certain rules that the portion of the trust that carries the S corporate stock as a separate trust, applying certain modifications to the general fiduciary tax rules. These rules are as follows:
- The income resulting from the portion of the trust that holds the stock is subjected to the highest federal income tax rate
- Only items of loss, income, credit, and deduction are allowed under under IRC 1361, which is applicable to S corporation and gains or losses from the sale of the stock
- Local or state income taxes and administration expenses can be deducted only to the extent that they are related directly to the income generated by the S corporation stock, or gained from the sale of the stock
Our Nevada Trust Administration Attorney Can Help You Determine the Solution Right for You
While it is possible to hold an S corporation in a trust, there are many challenges and rules associated with this option. At Boyer Law Group, our Nevada trust administration lawyer can advise you of what these are, help you determine which option is right for you, and overcome any challenges that may be presented along the way. Call us today at 702-255-2000 or contact us online to request a consultation with our experienced attorney and to get the legal help you need.