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CERTAIN TYPES OF TRUSTS can hold stock in S corporations. These "qualified subchapter S trusts" (QSSTs") will be subject, however, to the complex provisions of the grantor trust rules.
This article focuses on how those grantor trust rules apply particularly to QSSTs, and how those rules create pitfalls--and opportunities--for estate planners.
HOW TO BE A QUALIFIED SUBCHAPTER TRUST * To be a QSST, the trust instrument must provide that:
* There is only one income beneficiary during the life of the current income beneficiary;
* If any principal distributions are made during the income beneficiary's life, they must be made only to the income beneficiary; and
* The income interest of the current income beneficiary must terminate on the earlier of the beneficiary's death or the termination of the trust. Internal Revenue Code ("Code") Sec 1361(d)(3)(A). (All section references are to the Code unless otherwise indicated.) The IRS has ruled that a provision requiring the payment of "stub" income to the estate of the deceased income beneficiary would not invalidate the QSST. Rev. Rul. 92-64, 1992-2 C.B. 214.
If a trust does not contain all the required terms, it is possible to have the trust agreement reformed under state law. However, even if the reformation is retroactive for state law purposes, the S election is not retroactively saved. A new S election must be filed by the corporation after the reformation. See Rev. Rul. 93-79, 1993-2 C.B. 269.
The final regulations make clear that a qualified terminable interest property trust ("QTIP") under section 2056(b)(7) qualifies as a QSST. Treas. Reg. Sec 1.1361-1(j)(4).
Accounting Income Payout Requirement
Trust accounting income must be actually distributed or must be required to be distributed at least annually to one individual who is a citizen or resident of the United States. Sec 1361(d)(3)(B).
Under Treas. Reg. Sec 1.1361-1(j)(1)(i), if the trust instrument does not require that all income must be distributed currently, the trustee may elect to consider a distribution made in the first 65 days of a taxable as having been made on the last day of the preceding taxable year. Thus, the "65 day election" found in section 663(b) is a permissible way to ensure compliance with the all income payout requirement.
Election Requirement
The income beneficiary,...