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TAX CLINIC

thereof) which was treated under sec- ESBTs income at the highest marginal rate ap-
tion 676 as owned by the decedent of A trustee may elect to treat a trust as plicable to trusts and net capital gains
the estate . . . by reason of a power in the an ESBT. The ESBT election generally at the maximum capital gains rate. To
grantor (determined without regard to must be filed within two months and the extent that one portion of an ESBT
section 672(e))” (Sec. 645(b)(1)). Unlike 16 days of the date the S corporation is deemed to be owned by a grantor, the
ESBTs and QSSTs, no election is neces- stock is transferred to the trust. How- grantor trust rules apply; in that case,
sary for a grantor trust to be an eligible ever, if the trust holds C corporation it is permissible for a partial grantor
shareholder of an S corporation. stock and the corporation makes an trust to file an ESBT election, but the
S election that is to be effective as of grantor portion will be taxed under the
Testamentary trusts the first day of the tax year in which rules generally applicable to grantor
A testamentary trust is “[a] trust with it is made, the ESBT election must be trusts and not as part of the S portion.
respect to stock transferred to it pursu- made within two months and 16 days If a nonresident alien is a potential
ant to the terms of a will” (Sec. 1361(c) of the date the S election is effective current beneficiary, the grantor trust
(2)(A)(iii)). Although the estate is (Regs. Secs. 1.1361-1(m)(2)(iii) and rules do not apply, and the trust is taxed
the shareholder of the stock follow- 1.1361-1(j)(6)(iii)). Regardless of the under the regular ESBT rules.
ing the death of the original owner, number of S corporations whose stock
a testamentary trust that receives S is owned by the ESBT, only one elec- QSSTs
corporation shares from the estate is tion is required (unless the S corpora- A QSST is a trust with a single
a permissible shareholder for a period tions file at different service centers). income beneficiary who makes an
of two years following the transfer of To qualify as an ESBT, the permis- election (which can only be revoked
the S corporation stock to the trust. sible beneficiaries of the trust generally with IRS consent) to be treated as the
Upon the expiration of the two-year are limited to individuals, estates, and deemed owner (Sec. 1361(d)(3)). As
period, the testamentary trust becomes charitable entities. Certain government such, the Code generally applies the
an ineligible shareholder, unless the entities also may qualify as permissible grantor trust rules to a duly formed
trust qualifies as an eligible shareholder beneficiaries but only if the entity holds QSST, in which the current income
under another provision of the IRC. a contingent interest in the ESBT (i.e., beneficiary is treated as the shareholder.
a government entity may not be a po- However, upon disposition of the S
Voting trusts tential current beneficiary of an ESBT) corporation stock by the QSST, the
A voting trust is “[a] trust created (Sec. 1361(e)). A trust is precluded trust will be treated as the owner, and
primarily to exercise the voting power from qualifying as an ESBT if any any gain or loss recognized on the
of stock transferred to it” (Sec. 1361(c) interest in the trust has been acquired disposition will belong to the trust
(2)(A)(iv)). To qualify as an eligible by purchase (Sec. 1361(e)(1)(A)(ii)). and not to the income beneficiary
shareholder of an S corporation, the Further, QSSTs (discussed below), tax- (Regs. Sec. 1.1361-1(j)(8)). A QSST
voting trust must arise from a written exempt trusts, and charitable remainder cannot distribute any portion of the
agreement that (1) delegates the right trusts are ineligible to be treated as trust corpus to anyone other than the
to vote to one or more trustees; (2) ESBTs (Sec. 1361(e)(1)(B)). For pur- current income beneficiary during
requires payment of all distributions poses of the 100-shareholder limitation the beneficiary’s lifetime. All current
from the stock of the corporation to applicable to S corporations, each po- trust accounting income must be
the beneficial owners of such stock; tential current beneficiary of an ESBT distributed annually to the current
(3) requires title and possession of the is treated as a shareholder. Under the income beneficiary. Additionally,
stock to be delivered to the beneficial law known as the Tax Cuts and Jobs the income interest of the current
owners upon trust termination; and Act, P.L. 115-97, nonresident aliens are income beneficiary ceases upon the
(4) terminates on or before a specific permissible beneficiaries of an ESBT earlier of the beneficiary’s death or
date or event pursuant to the terms and will not impair the EBST’s eligibil- the termination of the QSST. Should
of the trust or state law (Regs. Sec. ity as an S corporation shareholder. the QSST terminate during the life of
1.1361-1(h)(1)(v)). Additionally, the For purposes of taxation, an ESBT the current income beneficiary, all the
beneficiaries (as determined under the is bifurcated into an S portion and a QSST assets must be distributed to
grantor trust rules) are treated as the non-S portion (Regs. Sec. 1.641(c)- the beneficiary. The income beneficiary
owners of their respective portions 1(a)). Income attributable to the S por- (rather than the trustee) of the trust
of the trust pursuant to the grantor tion of the ESBT is taxed to the trust makes the QSST election. Separate
trust rules. and is subject to tax on its ordinary elections are required for each S

22 May 2022 The Tax Adviser