Can a Trust Own an S Corp?

An S corporation is a legal entity just like a C corporation, but it has several distinct advantages. It provides shareholders with limited liability protection, and it is not subject to double taxation because profits and losses are divided between the shareholders and reported on individual income tax returns. But these types of entities have restrictions that do not apply to C corporations, including limits on who can own shares. 

So, if you own, manage, or are a beneficiary of a trust, an S corp may be a good investment for financial planning and income tax purposes, but you need to ensure that the type of trust is legally eligible to hold shares. 

Can trusts own S corp stock?

Yes, generally speaking, trusts can own S corp stock, but only specific types of trusts can be shareholders. 

Setting up a trust is a popular estate planning option for many people, as it allows them to protect and distribute their assets upon their death or in the event of becoming incapacitated without the trouble of going through probate. 

Oftentimes, grantors of a living trust previously owned S corp stock; when they move that stock into the trust, they must retitle it so that the shareholder owner is now the trust, not the individual. This means that the trust must qualify as an eligible S corporation shareholder, noted under Internal Revenue Code 1361. If an ineligible trust owns shares of an S corp, it could jeopardize the corporation’s tax status, forcing it instead to be taxed as a C corporation.

Ownership restrictions for S corporations

The primary reason for ownership restrictions with S corporations is to ensure that the business's generated income is reported to the Internal Revenue Service (IRS) each year. Because S corporations do not pay taxes on income generated by the company, individual owners must report the income on their tax returns. 

S corps have limitations on the types and number of shareholders. Only estates, individuals, and certain trusts can own shares in an S corp. Corporations, partnerships, and nonresident aliens cannot own stock.

Also, S corporations cannot have more than 100 shareholders. If the trust is a grantor trust, testamentary trust, or qualified subchapter S trust (QSST), the trust counts as one shareholder. However, the number of beneficiaries of an electing small business trust (ESBT) or voting trust are all counted as shareholders for an S corp.

If you fail to comply with these strict ownership rules, your S corp will lose its tax advantages.

Trusts that can own S corporation stock

There are several different types of trusts that are eligible to own S corporation stock: grantor trusts, QSSTs, ESBTs, testamentary trusts, and voting trusts. Let’s dive into the details of each one.

Grantor trusts

By establishing a grantor trust, the grantor (the person who sets up the trust and moves assets into it) retains control over the management of its assets. Grantor trusts may hold S corp stock, as long as the grantor is a U.S. citizen or resident. 

However, careful planning is required to avoid causing the company to lose its status if the grantor passes away or becomes incapacitated. Under these circumstances, the trust becomes an irrevocable trust. An irrevocable trust is not permitted to own S corporation stock. The trust is given a two-year grace period, plus two and a half months, after the grantor's death to distribute the stocks or elect to become a QSST or an ESBT. If the irrevocable trust holds the shares for longer than that time frame, the IRS revokes the S corp status.

Qualified subchapter S trusts (QSSTs)

A QSST may hold S corporation stock, provided it meets certain requirements. A QSST must have only one income beneficiary. This beneficiary must be a U.S. resident or citizen and must receive that stock if the trust terminates. Because this type of trust is a one-beneficiary trust, the distribution of the trust’s income is taxed at the individual level, making this option desirable for its straightforward, typically more cost-effective structure.

The beneficiary must elect to become a QSST either within two and a half months of the beginning of the company's first taxable year or two and a half months after the trust becomes an S corporation shareholder. If the trust was a grantor trust and the grantor dies, the single beneficiary has two years and two and a half months to elect a QSST. If a QSST election isn’t made within this time frame, the S corp can lose its tax status.

Electing small business trusts (ESBTs)

ESBTs can also hold S corporation stock, with a few additional requirements:

• The ESBT trustee must make the election within two and a half months of owning the stock or the company becoming an S corp. (The same post-grantor-death timeline applies to electing ESBT.)
• There may be more than one beneficiary, but all beneficiaries must be estates, individuals (including nonresident aliens), or certain charitable organizations.
• None of the beneficiaries are permitted to purchase their interest in the trust.

ESBTs are unique in that they are composed of two parts: the S corp portion and the non-S-corp portion. The S corp income is taxed at the trust level, which is often a much higher tax rate than the individual level. Then, the income from remaining assets in the trust are taxed separately (for example, as a grantor trust) and subject to different terms.

Testamentary trusts

You can create a testamentary trust through a will. To do this, you simply direct that shares of an S corp be transferred to a trust upon your death. However, like grantor trusts, testamentary trusts can only hold the shares for up to two years after the trustee's death without jeopardizing the S corp status. Before the two years is up, the beneficiary must either elect to become another type of eligible trust or distribute the stock to another shareholder. 

Voting trusts

Voting trusts are often formed to centralize voting power and maintain shareholder control over a company. Here’s how a voting trust works and its requirements when owning S corp stock: 

• A certain number of shareholders transfer their shares to one trustee, who agrees to vote in accordance with shareholder wishes. 
• A voting trust agreement typically has a set duration, at which point the shares are returned to the individual shareholders. The agreement must be filed with the U.S. Securities and Exchange Commission. 
• The individual shareholders are still treated as beneficiaries, meaning that they still receive dividends from the stock, but they must report this income on their individual tax returns.
• Beneficiaries need to meet the requirements for being an S corp shareholder. 

Considerations for trusts holding S corp stock

As you can see, although the short answer to “can a trust own an S corp?” is yes, there are several requirements to keep in mind that will influence your decision. Let’s review the key considerations:

• Timely elections. Making timely trust elections is crucial. There are strict time frames for electing eligible trust types, such as a QSST or ESBT, after certain events, like the death of a grantor or moving S corporation stocks into a trust.
• Beneficiary eligibility. Depending on the trust type, beneficiaries must meet specific criteria, such as being U.S. citizens or residents.
• Tax implications. Some trusts are taxed differently than others, and therefore have different financial implications for the beneficiaries. For instance, ESBTs are taxed at the highest marginal rate on S corporation income, meaning that the tax burden may be higher for those beneficiaries.

With various regulations and tax implications, making financial planning decisions for your estate and your family can be complex. Ease the process by seeking assistance from a tax advisor or financial planner and getting the estate planning guidance you need from LegalZoom experts.

FAQs

Why does a trust need to meet specific criteria to own S corporation stock?

A trust needs to meet specific criteria to own stock in an S corporation because an S corp has limitations on the number and type of shareholders. It can’t have more than 100 shareholders, and they typically need to be U.S. citizens or residents. For this reason, trusts—and oftentimes their beneficiaries—need to align with these requirements.

What happens if an ineligible trust owns S corporation stock?

If an ineligible trust owns stock in an S corporation, the company risks losing the favored S corp taxation status, meaning that it may default to being taxed as a C corporation.

Can an S corp have a trust as a shareholder?

Yes, an S corp can have a trust as a shareholder, as long as the trust qualifies as a shareholder according to IRS regulations for S corporations. 

Can I transfer ownership of a business to a trust?

Many grantors decide to transfer assets to a trust, including ownership of their business, but the process for doing so differs depending on the type of entity. For example, transferring ownership of an LLC to a trust typically requires getting majority owner approval, while transferring an S corp to a trust requires that the shareholder stocks are transferred to other eligible shareholders.