QSSTs and ESBTs: no longer mutually exclusive.

• Author: Wong, Alan
• Position: Qualified subchapter S trusts, elective small business trusts

Subchapter S corporations are able to have certain trusts as qualified shareholders and retain their S status. Two of those trusts are qualified subchapter S trusts (QSSTs) and electing small business trusts (ESBTs). A trust could elect to be either a QSST or an ESBT, but not both.

Qualified Subchapter S Trust Status

The beneficiary of a QSST is treated as the owner of that portion of the trust that consists of stock in an S corporation--i.e., the current income beneficiary of a QSST is directly taxed as if he or she is the grantor of that portion of the trust. The trust must meet certain terms under Sec. 1361(d)(3) in order to qualify as a QSST:

* During the life of the current income beneficiary, the trust can have only one income beneficiary of the trust; * Any corpus distributed during the life of the current income beneficiary may be distributed only to that beneficiary;

* The income interest of the current income beneficiary in the trust must terminate on the earlier of the beneficiary's death or the termination of the trust;

* Upon the termination of the trust during the life of the current income beneficiary, the trust must distribute all of its assets to such beneficiary; and

* All the trust's income is distributed (or required to be distributed) currently to one individual who is a citizen or resident of the United States.

Although a QSST by definition can have only one current income beneficiary, it is possible to have multiple beneficiaries, provided separate shares in the trust are created with respect to each beneficiary. Sec. 1361(d)(3) provides that a substantially separate and independent share of a trust will be treated as a separate trust. Therefore, a single trust may technically have multiple beneficiaries and still qualify as a QSST as long as each beneficiary has a separate and independent share in the trust.

In Rev. Rul. 93-31, the IRS ruled that a separate share of a trust cannot qualify as a QSST if there is even a remote possibility that the trust corpus will be distributed during the current income beneficiary's lifetime to someone other than the current income beneficiary.

The possibility of multiple or ineligible beneficiaries after the death of the current beneficiary does not disqualify the trust during the current income beneficiary's lifetime.

Electing Small Business Trust Status

Unlike a QSST, an ESBT can have multiple beneficiaries, and trust income can be accumulated or sprinkled among multiple...