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Under this revenue ruling, target share- Holdco or contribute capital directly
holders form a new holding company into the target in exchange for an inter- For a grantor trust to
(Holdco), then transfer their stock held est in the target. Both would result in a
in the target to Holdco in exchange for stepped-up basis in the underlying assets qualify as an eligible
Holdco stock. Effective on the same date, for the buyer/new investor (see Rev. Rul. shareholder of an
Holdco properly makes an election to 99-5, Situations 1 and 2). Note, however,
treat the target as a qualified Subchapter that the original target would no longer S corporation, the
grantor (or a trust
S subsidiary (QSub) by filing Form 8869, be an S corporation and would be treated
Qualified Subchapter S Subsidiary Election. as a partnership for income tax purposes. beneficiary if Sec. 678
Under Rev. Rul. 64-250, Holdco should From Holdco’s perspective (the seller in
applies) must be the
be viewed as retaining the target’s original the transaction), any sale of the inter-
S election status without filing a new S est in the LLC would generate similar deemed owner of the
election if it is involved in a qualified F treatment and considerations as those
reorganization and Holdco qualifies as identified under Scenario 2. Accordingly, entire trust.
a small business corporation (see Sec. Holdco may request a gross-up if the new
1361(b)). investors choose to acquire an interest in
Once these steps have been com- the LLC. trusts, testamentary trusts, voting trusts,
pleted, the goal is to convert the target ESBTs, and qualified Subchapter S
into a limited liability company (LLC) Planning for efficiencies trusts (QSSTs) are permissible S corpo-
— how this is accomplished will depend Careful tax planning is critical for taxpay- ration shareholders (Sec. 1361(c)(2)).
on the facts and circumstances. For ex- ers contemplating acquiring or selling
ample, if the target is legally an LLC but their existing S corporation business(es). Grantor trusts
previously was deemed to have made a With proper planning, buyers and sellers In a grantor trust, the grantor (also
check-the-box election under Regs. Sec. may be able to create efficiencies with known as the settlor or trustor) retains
301.7701-3(c)(1)(v)(C) to be classified as respect to tax cash flow as a result of ac- certain powers to control and direct the
a corporation for tax purposes, the target quiring or selling the S corporation target. income and/or assets of the trust. For
can file Form 8832, Entity Classification From Peter Diakovasilis, CPA, Long income tax purposes, a grantor trust is a
Election, and elect to be treated as a DRE. Island, N.Y. disregarded entity, such that the income,
Note that under Regs. Sec. 301.7701-3(c) deductions, and credits are reported
(1)(iv), an entity generally is prohibited Trusts as S corporation on the grantor’s individual income tax
from changing its entity classification shareholders return (Sec. 671).
within 60 months of a previous entity An S corporation structure is an advan- For a grantor trust to qualify as an
classification election (other than an tageous option for many companies; eligible shareholder of an S corporation,
original entity classification election). however, business owners must ensure the grantor (or a trust beneficiary if Sec.
Careful consideration should be given to that they comply with the mandates of 678 applies) must be the deemed owner
the timing of such elections (see Regs. the Internal Revenue Code (IRC) and of the entire trust. The deemed owner of
Sec. 301.7701-3(g)(3)(i)). Accordingly, Treasury regulations to avoid losing the wholly owned grantor trust must be
the target should consider making this their status as an S corporation. These a U.S. citizen or resident. If the deemed
election effective at least two days from mandates include a 100-shareholder owner of the wholly owned grantor trust
the original QSub election. limit, and each shareholder must qualify dies, the trust continues to qualify as a
If the target was a per se entity, such as an eligible S corporation shareholder. permissible shareholder for two years
as a state law corporation, a potential Eligible shareholders include individu- following the date of death (“nongrantor
solution might be to convert or merge als who are U.S. residents or citizens, administrative trust”) (Sec. 1361(c)(2)
the target into an LLC, depending on the as well as estates of decedents or indi- (A)(ii)). However, if the trustee of a
state law of the target. viduals in a Title 11 (bankruptcy) case qualified revocable trust and the execu-
Upon the completion of the transac- (Sec. 1361(b)). Nonresident aliens are tor of the estate submit a Sec. 645 elec-
tion, Holdco is an S corporation and prohibited from holding S corporation tion, the trust will be treated as part of
wholly owns an LLC (the target) that stock, except as discussed below for the estate, and the estate will qualify to
is treated as a DRE for income tax pur- electing small business trusts (ESBTs). hold S corporation stock for the dura-
poses. New investors can either acquire Generally, a trust cannot hold stock tion of the election period. A qualified
a percentage interest in the target from of an S corporation; however, grantor revocable trust is “any trust (or portion

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