Placing S stock in trust.

• Author: Bowman, Karen
• Position: Subchapter S corporations

Several trusts are not eligible to be S shareholders and their ownership of S stock immediately terminates an S election. There are, however, five trusts that may be eligible shareholders. 1. Grantor trust. 2. Sec. 678 trust. 3. Qualified subchapter S trust (QSST). 4. Testamentary trust. 5. Successor trust.

The first three trusts allow for only one income beneficiary; the last two, while they allow for more than one income beneficiary, have a limited life. At the end of the limited life of the testamentary rust and the successor trust, a trustee must convey the trust stock to an individual or another eligible trust.

Grantor trust

Most estate planners prefer to set up inter vivos and revocable trust arrangements, which become irrevocable only on the grantor's death. Property placed in an inter vivos trust can escape delay, court interference and expensive probate. As long as the grantor retains the income and control over a revocable inter vivos trust, he is treated as the trust owner and the grantor trust has no tax liability.

In the same way, grantors are deemed to own S stock in grantor trust outright (Sec. 677). While the grantor trust rules tax the deemed owners on income from any part of the grantor trust corpus they control, Sec. 136(c)(2)(A)(i) states that the grantor trust is an eligible S shareholder only if its deemed owner controls the income from all its corpus.

A grantor retained income trust (GRIT) gives the income beneficiary a right to all the income that the trust corpus earns and is therefore deemed the owner of the trust income. Deemed ownership changes the GRIT into an eligible S shareholder (Sec. 674(a)). By using a GRIT, a grantor may reduce the taxable value of a gift of the remainder interest by the present value of its retained income interest. If a grantor survives the term of the GRIT, the remainderman will own the S stock outright and the stock will be outside the grantor's estate.

Unfortunately, GRITs have major drawbacks, especially in the context of holding S stock. If the grantor dies before the GRIT term expires, the property comes back into the grantor's estate at death. Additionally, in a family context, the GRIT must pay the grantor/beneficiary an annuity interest under the new Sec. 2702(a) "anti-freeze rules" in order to discount the gift by the present value of the income interest. To be safe, a GRIT holding S stock should pass out all S income distributions currently. Sometimes it is difficult for a...