Trusts as Eligible Shareholders of an S Corporation

It is a common estate planning practice for small business owners to transfer ownership of their business interests into their revocable living trusts. These transfers can be made during the business owner's lifetime or with a "transfer on death" (TOD) designation. 

This estate planning technique has many benefits, a major one being the avoidance of probate of the business interest at death, but only if the terms of the trust provide the necessary protections, AKA ensuring the trust is an eligible shareholder of an S corporation. 

The are certain factors to consider in these instances. So long as the business owner is living, "his or her revocable trust is treated as a 'grantor trust' for income tax purposes, and as such, is an eligible S corporation shareholder." Upon the death of the business owner, the trust will remain an eligible shareholder for a period of two years. After the two year period, the trust will be required to distribute stock outright to an eligible shareholder, unless the stock is to remain in the trust, in which case the trust must qualify as a qualified subchapter S trust (QSST) or an electing small business trust (ESBT). 

In order for the trust to qualify as a QSST, the trust "must require that all of the net income be distributed to a single beneficiary." To qualify as an ESBT, "the Trustee may have discretion to accumulate income, and there may be multiple beneficiaries."

For more information on the tax benefits of QSST and ESBT trusts: 

See Rebecca C. Bowen, Trusts as Eligible Shareholders of an S Corporation, Thompson McMullan P.C.: Commentary, March 17, 2022. 

Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.