Eligible S Corporation shareholders include individuals, estates and certain types of trusts, among others. When a shareholder dies, estate administration takes time, but estates and administrative trusts cannot own S Corp shares indefinitely. Complex IRS rules determine what happens with the shares, including “reasonable” periods of ownership before the shares must be transferred, or elections made, otherwise the corporation risks losing S Corp status. We’re here to provide expert guidance on the IRS election options available to protect S Corp status during administration of the decedent’s estate and beyond.
The IRS permits ownership of S Corp shares for the following time periods following the death of a shareholder:
- Grantor trusts, which become irrevocable trusts upon the grantor’s death, and estates not required to file an estate tax return (Form 706) can hold the shares up to 2 years post date of death.
- Estates required to file an estate tax return (Form 706) can hold the S Corp shares for the later of 2 years post date of death or 6 months after the date of final estate tax liability determination.
Keep The “S” in S Corp
After the time periods above, the S Corp stock must be owned by another eligible owner or risk losing S Corp status. While individuals who receive S Corp shares may hold these shares without an election, certain elections must be in place to permit longer periods of successor trust ownership.
Qualified Subchapter S Trusts (QSST) require the trust’s single income beneficiary to receive and report income on an individual tax return. When a trust’s beneficiary makes the QSST election during their lifetime, if the beneficiary and distribution rules continue to be met after their death, the trust will continue to be a QSST, thereby protecting S Corp status.
Electing Small Business Trusts (ESBT) can have multiple beneficiaries, do not require distribution of income and preserve S Corp status. This election, made by the trustee, is not used when income tax is the only consideration because income held in the trust is taxed at the highest individual rate. Rather, it can be effective in other complex planning situations. For example, when a child from a wealthy family gets married, the ESBT election can help protect assets from becoming marital property in the event of a divorce.
Generally, issues arise when the QSST or ESBT election has not been properly made by 2 months and 15 days post effective date of the desired status. Beneficiaries or successor trustees must act by specific IRS deadlines or face the cancellation of S Corp status for the entire business and all owners. If this happens, the company becomes a C Corp, subject to vastly different taxation requirements.
A smart tax and estate planning strategy includes an in-depth review of what will happen to ownership of the S Corp shares upon death of a current shareholder. While late election relief is available, in all but the simplest of scenarios an IRS Private Letter Ruling (PLR) may be needed to correct a failure to complete a QSST or ESBT election. This is a costly option subject to a variety of restrictions with a hefty 2023 filing fee up to $38,000 for each request submitted.
Planning ahead to properly structure trusts, rather than reacting when an error occurs, avoids unnecessary time delays and expense. Contact your Rehmann advisor now for tax efficient estate planning that gives you and your heirs peace of mind.
