Estate Planning for a Family Business puts the company stock into a revocable trust, which is right while the owner is alive. The day the owner dies, that stock is on a two year clock.
An S corporation election can be lost by a transfer nobody reviewed for it. No notice arrives and no filing is rejected. The loss is simply effective back to the day it happened.
A revocable living trust is the standard California answer to probate. S corporation stock is the exception. Under Internal Revenue Code section 1361(b)(1)(B) a shareholder must be an individual, an estate, or one of a short list of trusts. A partnership, an LLC taxed as a partnership, and most trusts are not on it.
While the owner is alive this is settled: section 1361(c)(2)(A)(i) treats a trust owned entirely by a United States citizen or resident under the grantor trust rules as eligible, and a revocable trust is exactly that. Death changes what the trust is. Section 1361(c)(2)(A)(ii) keeps it eligible for two years from the day the deemed owner dies, after which it has to qualify in its own right. If the sub-trusts the document creates, a survivor's trust, a bypass trust, a share for each child, do not qualify, the election terminates and the company is a C corporation.
A QSST has one beneficiary and has to pay out. Section 1361(d) permits a qualified subchapter S trust: one current income beneficiary who is a United States citizen or resident, all trust income distributed currently to that person, corpus distributable during their life only to them, and the income interest ending at their death or the end of the trust. The beneficiary makes the election, not the trustee.
An ESBT can have several beneficiaries and pays the top rate. Section 1361(e) permits an electing small business trust, which fits a trust that sprinkles among children. The price is in section 641(c): the S portion is taxed at the highest individual rate, with the graduated brackets unavailable. Here the trustee elects.
The election is due within two months and sixteen days. That runs from the date the stock is transferred to the trust, and the regulations under section 1.1361-1 start the same clock the day a post death grace period ends. The two years run from the date of death, not from the day somebody first opens the corporate records, and nothing in an ordinary trust administration prompts either filing.
Separate shares count as separate trusts. Section 1361(d)(3) treats a substantially separate and independent share, in the sense of section 663(c), as a separate trust here. One document leaving equal shares to three children can hold the stock as three QSSTs. A single discretionary pot for all three cannot.
Neither answer is free, and that belongs in the conversation before drafting. A QSST requires all trust income to be distributed currently to one beneficiary, and that beneficiary is taxed on the corporation's allocated income whether or not the corporation distributed any cash. A company retaining earnings to buy equipment can hand a QSST beneficiary a tax bill and a trust obliged to distribute the little it actually received. An ESBT fixes the multiple beneficiary problem and gives up the brackets to do it, every year, for as long as it holds the shares.
The harder point is that the protection a trust is chosen for is often what disqualifies it. Spendthrift discretion, sprinkling among children, an accumulation period for a beneficiary who is nineteen: those terms are what make a trust ineligible as a QSST, and they are usually the reason the trust exists. Sometimes the honest answer is that these shares should not sit in that trust at all, and should pass outright with a funded buy sell agreement doing the work.
When it goes wrong it is expensive rather than impossible. Section 1362(g) bars a new election for five years without the consent of the Service. Section 1362(f) allows relief for an inadvertent termination, which means a ruling request and a user fee, and Revenue Procedure 2013-30 gives a simplified path for a late QSST or ESBT election inside the period it describes.
In California an S corporation pays 1.5 percent of net income under Revenue and Taxation Code section 23802 rather than the 8.84 percent corporate franchise rate, subject to the $800 minimum. Losing the federal election takes the state treatment with it.
Three facts before funding anything inside Estate Planning for a Family Business: whether an S election is actually in force, what the sub-trusts say about income and beneficiaries, and the date the two year clock would start.
General information about California and federal law, not legal advice, and no attorney-client relationship is created. How these rules apply depends on your corporate records and your trust instrument.
Bring the trust, the stock certificates and the last Form 1120-S.
