Irrevocable grantor trust can provide estate tax planning opportunity for S shareholders.

• Author: Dunn, William J.
• Position: Brief Article

The use of an irrevocable grantor trust for an S corporation can minimize estate taxes while retaining flexibility in the trust's terms.

The use of a grantor trust generally has the disadvantage of having trust earnings taxed to the grantor during his life and the trust corpus includible in the grantor's estate at death. However, if the trust arrangement is structured to allow the grantor to retain certain powers or interests in the trust property, the grantor will be deemed the owner of the trust for income tax purposes (and, therefore, the trust will be a qualified shareholder in the S corporation), but will not be treated as the owner of the trust for Federal estate and gift tax purposes. As a result, unlike a qualified subchapter S trust (QSST), the trust may provide for discretionary or sprinkle-type distributions to beneficiaries.

Sec. 1361(c)(2)(A)(i) provides that for purposes of Sec. 1361(b)(1)(B) a trust may be an S shareholder if it is treated as owned by a U.S. citizen or resident. This rule requires that the trust be treated as a grantor trust for income tax purposes but not for estate inclusion purposes. Therefore, due to the irrevocable gift in trust, the property will be removed from the shareholder's taxable estate without impairing S status. Although the initial contribution will be treated as a current gift, future appreciation is shifted away from the grantor. Further, the current economic climate may present the opportunity to place a low value on the stock, which will minimize gift tax exposure.

For example, if an S shareholder transfers stock to an irrevocable grantor trust and the grantor retains the power...