Can a Trust Own an S Corp: Everything You Need to Know
Can a trust own an S corp? This is a question that many business owners wonder about. 3 min read
Updated November 9, 2020:
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.
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
- Qualified Sub-chapter S
- Electing Small Business
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.
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