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IRS Liberalizes Rules on S Corporation Ownership by Trusts

Once upon a time, S corporations (the kind which pay no federal income tax at the corporate level) had to be owned by a few individuals. Then the concept of "a few" expanded. After that, a limited form of trust was allowed to own stock in S corporations. Then other kinds of trusts joined the game. Now, the IRS has provided guidance on the procedure for converting one kind of trust to another kind. Of course, this assumes that the trust instrument itself permits the change.

The two types of trust involved here are the Qualified Subchapter S Trust and the Electing Small Business Trust. The essential differences between them are that (1) the Qualified Subchapter S Trust may have only one current income beneficiary while the Electing Small Business Trust may have several; (2) during the lifetime of the current income beneficiary, the principal of the Qualified Subchapter S Trust may be distributed only to the current income beneficiary during that beneficiary's life while the Electing Small Business Trust is not bound by a comparable restriction; and (3) each person eligible to receive principal or income from the Electing Small Business Trust is counted as one of the permitted 75 shareholders of an S corporation, a complication which does not apply to a Qualified Subchapter S Trust, which has only one income and principal beneficiary at a time.

As times change, so do needs. Consequently, if you are presently bound to one of these trust arrangements, the time may have come for you to try the other - if conditions permit.

The recent regulations are largely technical in nature, permitting the Qualified Subchapter S Trust to turn into an Electing Small Business Trust (and vice versa) upon satisfying eligibility requirements (one of which is that a previous conversion has not been made within the preceding 36 months). Once the technical criteria have been met, IRS approval is automatic.

If the possibility interests you, you should get in touch with us. We can review your trust documents and tell you if your Electing Small Business Trust can qualify as a Qualified Subchapter S Trust (or vice versa) and help you through the technical requirements of the conversion.

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