An S Corporation, also known as an S Corp, is a tax designation for both corporations and LLC’s. S Corp tax structures allow shareholder’s the ability to draw a salary and collect dividends. S Corporations also allow for pass-through taxation, much like a traditional pass- through entity, such as a single member LLC. It is important to keep in mind that there are certain requirements that must be met in order to ensure eligibility of an S Corp tax election. These requirements include: (i) the company can have no more than 100 owners; (ii) the owners must be citizens or lawful permanent residents; (iii) the owners must be individuals or qualified entities; and (iv) there shall only be one class of stock.
Can a trust be a shareholder of an S Corporation?
Generally, trusts cannot hold stock of an S Corporation, however, there are a few trust structures that allow for S Corporation shareholder status. These trust structures include grantor trusts, testamentary trusts, voting trusts, electing small business trusts (ESBT’s), and qualified Subchapter S trusts (QSST’s).
Which types of trusts are eligible S Corporation shareholders?
For a grantor trust to qualify as a shareholder of an S Corporation, the grantor must be: (i) the owner of the entire trust, and (ii) must be a U.S. citizen or lawful permanent resident. Once the grantor passes away, the trust continues to qualify as a shareholder for two years following the date of death. Under testamentary trusts, if the trust receives S Corporation shares from an estate, it is a permissible shareholder for a period of two years following the transfer of stock. Voting trusts, created to exercise the voting power of stock transferred to it, allow for S Corporation shareholder status if: (i) the voting trust arises out of a written agreement that delegates the voting right to the trustees; (ii) requires payment of distributions for the stock; (iii) requires title and possession of the stock to be delivered to the owners upon trust termination; (iv) and will terminate according to a specific date or event under the terms of the trust or state legislation.
The beneficiaries of the voting trusts are treated as owners following the grantor trust rules. ESBT’s and QSST’s have additional requirements. A trustee may elect to treat a trust as an ESBT within two (2) months and sixteen (16) days of the date when S Corporation stock was first transferred into the trust. ESBT’s can allow for numerous S Corporation stocks to be owned, yet only need to file for one election. Qualification for an ESBT requires the beneficiaries to be individuals, estates, or charitable entities. A trust is exempt from ESBT qualification if any interest in the trust has been acquired by purchase. One interesting attribute of the ESBT is that a beneficiary is allowed to be a nonresident alien and it will not impair the ESBT’s eligibility to be an S Corporation shareholder.