Checklists for determining whether a trust is a valid S shareholder.

• Author: Traum, Sydney S.

This checklist is intended to help CPAs spot issues in determining whether a trust is eligible to hold S corporation stock. It has four parts; a trust needs to meet the criteria of Part I, II, III or IV to be a valid S shareholder. For example, a trust that does not qualify as a qualified subchapter S mist (QSST) under Part I might qualify as an electing small business trust (ESBT) under Part II, or meet the requirements of Part III or IV.

For a QSST election, the trust beneficiary chooses whether to elect separately for each S corporation whose stock is owned by the trust. For example, a mast might have a QSST election in place for stock in one S corporation it owns, but not for another. A QSST election might be timely as to one S corporation and late as to another. In any event, if a QSST election is made, it applies only to the S corporation named in the election.

Although the checklist provides deadlines, a failure to satisfy them will not necessarily be fatal if remedial action is taken. Generally, if a late ESBT or QSST election is caught within 24 months of the election's original due date, Rev. Proc. 2003-43, 2003-1 CB 998, might provide expedited relief. If the late election does not qualify for Rev. Proc. 2003-43 relief, a letter ruling might provide relief under Sec. 1362(f) from the associated inadvertently invalid S election or inadvertent S termination. Congress mandated the IRS to be very lenient in granting inadvertent termination relief, as long as the taxpayer has made an honest mistake and all of the affected shareholders consent to the relief. However, tax advisers should consult applicable authority and make their own determination.

Finally, special attention should be paid to the limit on the number of shareholders. Each of the eligible masts has specific rules as to which individuals are treated as owners for purposes of this limit. A mist qualifying as an eligible shareholder may cause the number of S shareholders to exceed the 100 limit (75 for years beginning before 2005) and, thus, terminate the S election. Spouses always count as one shareholder for purposes of the number-of-shareholders test. For tax years beginning after 2004, members of a qualifying family are treated as one shareholder, allowing the actual number of shareholders to significantly exceed 100. For purposes of the 100 limit role in general, and the family rule in particular, a person is not counted twice even if that person owns or is deemed to own S stock in more than one capacity (e.g., as a direct owner, as a current income beneficiary of a QSST, or as a potential current beneficiary of an ESBT).

This checklist is not intended to (and does not) address every possible mast situation, such as those involving exempt trusts covered in Sec. 1361(c)(6). It should be used to determine whether a mast can validly hold S stock.

Authors' note: The authors thank the 2004-2005 AICPA S Corporation Taxation Technical Resource Panel for its review of this manuscript.

THE AICPA S TRUST TASK FORCE (SYDNEY S. TRAUM, CHAIR; STEVEN J. BROWN AND STEVEN B. GORIN, MEMBERS; LAURA HOWELL-SMITH AND KENNETH N. ORBACH, REVIEWERS; AND MARC A. HYMAN, AICPA TECHNICAL MANAGER)

1. QSST Determination (Sec. 1361(d)) Name of S corporation-- Questions Yes/No Date Completed 1. Is the trust a domestic trust? -- -- * If no, the trust does not qualify; see Sec. 701(a)(31)(B) and (a) (30)(E) for the definitions of foreign and domestic trusts. 2. Do the trust terms permit more than one income beneficiary during the current income beneficiary's life? -- -- * If yes, the...