Key Takeaways

  • Trusts can own shares in an S corporation, but only certain types of trusts qualify under IRS rules.
  • Permissible trust types include grantor trusts, testamentary trusts, QSSTs, and ESBTs.
  • S corporation characteristics include pass-through taxation, limited shareholder types, and restrictions on ownership.
  • A trust must meet specific IRS eligibility rules to maintain the S corporation’s status.
  • Certain trusts, such as ESBTs and QSSTs, require IRS elections and compliance with income distribution rules.

Can a Trust Own an S Corp

Can a trust own an S corp? This is a question that many business owners wonder about. Trusts are a type of business in which a trustee will control certain assets instead of but still for the advantage of the trust's designees.

Trusts are created when a person, called the grantor, forms the trust and provides the assets for the trustee to manage. The grantor also will be the one that sets out the trust's criteria for distributing its assets. The trustee is also named by the trust's creator.

The trustee is designated with looking out for the trust in the name of the trust's designees. The trustee will oversee the assets based on the trust's terms and rules. Trusts are normally best for situations where the designees of the trust can't properly oversee the assets themselves, or the grantor wants to make the trust only provide the assets to the designees under certain terms.

Definition of S Corp

S corporations are a type of legal business form that combines features of pass-through tax entities and corporations.

Essentially an S corporation permits a business to be structured as a regular C corporation but to allow most of its profits and losses to be passed on to its owners, thereby avoiding double taxation.

The S corporation's owners will pay their share of the S corporation's profits and losses on their individual tax returns, rather than the S corporation paying them.

Regular C corporations often face double taxation when the corporate income is taxed at the business entity level and then again when it is distributed as a dividend to shareholders. The S corporation avoids this double tax, but S corporations aren't always more tax-friendly and also have many strict restrictions.

S corporations are not permitted, for example, to have certain types of owners. Many business types ranging from corporations to partnerships are not permitted to be an S corporation owner. S corporations are also restricted to 100 or less stockholders.

The S corporation's stockholders end up being only able to include citizens and resident aliens, and certain specific organizations such as some types of estates, trusts, and other organizations.

S Corporation Characteristics and Restrictions

S corporations are defined by several distinct characteristics under the Internal Revenue Code, particularly Subchapter S. One of the primary advantages is pass-through taxation, which allows profits and losses to be reported on the personal tax returns of shareholders, thereby avoiding double taxation at the corporate level.

Key characteristics of an S corporation include:

  • Pass-Through Taxation: Profits and some losses pass directly to shareholders without being subject to corporate tax rates.
  • Ownership Restrictions: S corps may not have more than 100 shareholders and must only issue one class of stock.
  • Eligible Shareholders: Only U.S. citizens, resident aliens, certain types of trusts, and estates can own shares.
  • IRS Election Requirement: The business must file Form 2553 with the IRS to elect S corporation status.
  • Limited Duration for Certain Owners: Estates can only hold S corp stock for a limited time post-death (generally up to two years).

These features make S corporations attractive for small businesses seeking corporate benefits while avoiding the burden of double taxation.

Types of Trusts Permitted as Shareholders of an S Corporation

Only certain kinds of trusts can be S corporation owners. The trust needs to be a U.S.-based trust under one of the following classifications:

  • Grantor Sub-part E
  • Testamentary
  • Voting
  • Qualified Sub-chapter S
  • Electing Small Business

Qualified Subchapter S Trusts (QSSTs)

A Qualified Subchapter S Trust (QSST) is a special type of trust that can own shares in an S corporation. For a trust to qualify as a QSST:

  • All income must be distributed annually to a single income beneficiary.
  • The beneficiary must be a U.S. citizen or resident and is treated as the direct shareholder for tax purposes.
  • The trust must elect QSST status by filing an election with the IRS (Form 2553 and QSST Election Statement).

If a trust fails to meet the QSST requirements or does not make the proper election, it may jeopardize the S corporation’s status. These trusts are commonly used in estate planning when a parent leaves S corp stock to a child or other heir.

Grantor Trusts

Grantor trusts are those that are created by a U.S. citizen and that fit the terms of sub-chapter J Sub-part E in the IRS code.

As a grantor trust, the trust's profits and assets are considered owned by either the trust's creator or by a designee of the trust. The tax liability of the trust may then be passed to the owners. Grantor trusts are automatically considered S corporations, essentially.

Married couples are considered a single unit for the trust's purposes. The grantor trust thereby will pass through the trust's income to the beneficiary or grantor, or the couple in the case of married couples.

The grantor trust is only permitted to have one owner for tax purposes. These trusts are required otherwise to be allowed under a different IRS section. Grantor trusts are a useful tool for estate planning and often use S corporations.

Estates are often structured so that the grantor trust will allow the trust's income to pass through to the owner, but the trust won't be considered as part of the owner's estate, thereby avoiding potential liability for estates.

Common trust forms used for estates include trusts based on retained annuities and those that are intentionally defective and irrevocable.

The terms for a full grantor trust are strict, and it is essential to make sure these trusts fulfill the criteria fully.

The grantor trust will need to fully qualify under the IRS’s Sub-part E. If the trust does not fulfill the terms, it will no longer be a permitted S corporation stockholder under that section, which can lead to significant consequence and complications.

Electing Small Business Trusts (ESBTs)

An Electing Small Business Trust (ESBT) is another trust type eligible to hold S corporation stock. Unlike QSSTs, an ESBT can have multiple beneficiaries and does not require income distribution.

Important ESBT characteristics include:

  • The trust must be a domestic trust with only eligible S corporation shareholders as beneficiaries.
  • The trustee must file a timely ESBT election with the IRS using a written statement attached to the trust’s tax return.
  • Taxation occurs at the trust level for S corporation income, using the highest individual income tax rate.
  • The ESBT is treated as two separate trusts for tax purposes—one for S corporation income and another for all other income.

ESBTs offer flexibility in estate and succession planning, especially for trusts with multiple beneficiaries or those that do not wish to distribute all income.

Testamentary Trusts and Voting Trusts

Testamentary Trusts are created through a will and come into effect upon the death of the testator. These trusts can hold S corporation stock for up to two years after the decedent's death without affecting S corp status. To continue holding shares afterward, the trust must qualify as a QSST or ESBT.

Voting Trusts are formed when shareholders transfer their shares to a trustee, often for coordinated management or voting control. These trusts are allowed to own S corp shares as long as all beneficiaries are eligible shareholders.

Both trust types must ensure compliance with S corporation requirements to avoid inadvertent termination of S status.

Frequently Asked Questions

  1. Can any trust own an S corporation?
    No. Only specific trusts—such as grantor trusts, QSSTs, ESBTs, testamentary trusts, and voting trusts—can qualify under IRS rules.
  2. What happens if an ineligible trust owns S corporation stock?
    The S corporation may lose its tax status retroactively to the date the ineligible ownership occurred, resulting in unexpected corporate-level taxation.
  3. What is the main difference between a QSST and an ESBT?
    A QSST requires all S corporation income to go to a single beneficiary, while an ESBT can have multiple beneficiaries and pays tax on S corp income at the trust level.
  4. Can a revocable trust own S corporation stock?
    Yes, if it qualifies as a grantor trust under IRS Subpart E rules and is treated as owned by a single individual.
  5. How do I make a QSST or ESBT election?
    You must file a written election with the IRS, typically attached to the trust’s tax return, and follow the timing and procedural rules set by the IRS.

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