Power to make distributions to nonexistent trusts does not make them potential current ESBT beneficiaries.

• Author: MacDonough, Laura M.
• Position: Electing small business trusts

Many trusts allow a trustee, at his discretion, to make distributions either directly to a beneficiary or in trust for such beneficiary. The effect of this power in determining the potential current beneficiaries of a trust intending to be an electing small business trust (ESBT) was unclear when no trusts had been identified or created to receive such distributions. In Letter Ruling 9930035, the IRS ruled a trustee's power to make distributions in trust is disregarded in determining the potential current beneficiaries of the mast, when no trusts have been identified or exist to receive such distributions.

For a trust to qualify as an ESBT, in addition to meeting other requirements, it may only have, as beneficiaries, individuals, estates and Certain charitable organizations. In addition, all potential current beneficiaries must be eligible S shareholders. Under Sec. 1361(e) (2), the term "potential-current beneficiary" means, with respect to any period, any person who at any time during such period is entitled to, or at the discretion of any person may receive, a distribution from the trust's principal or income.

In Notice 97-49, the Service provided that the term "beneficiary" did not include a distributee trust (other than a trust described in Sec. 170(c)(2) or (3)), but did include those persons who had a beneficial interest in the property held by the distributee trust. A distributee trust is a trust that is receiving or may receive a distribution from an intended ESBT, whether the rights to receive the distribution are fixed or contingent, or immediate or deferred. However, this rule does not apply in determining the trust's potential current beneficiaries. Instead, under the notice, if a distributee trust became entitled to, or at the discretion...