QSST Election for the Bridge Trust to hold S-Corp Shares

We are often asked when a grantor trust may hold S-Corp Stock. This article addresses this question in the context of the Bridge Trust, which is a Grantor Trust, as well as being irrevocable.

Whether a grantor trust is revocable or irrevocable does play a significant role in how it is treated for tax purposes, especially when it comes to holding S-Corporation stock. However, the crucial aspect to consider is not merely the revocable or irrevocable status of the trust but whether it is classified as a grantor trust under the tax code.

Grantor Trusts: Revocable vs. Irrevocable

Revocable Trusts: By default, revocable trusts are considered grantor trusts because the grantor retains the power to revoke the trust and reassume ownership of the trust assets. The income from the trust is typically taxed to the grantor, and for tax purposes, the grantor is considered to own the trust assets.

Irrevocable Trusts: An irrevocable trust can also be treated as a grantor trust if the grantor retains certain powers or interests as specified by the Internal Revenue Code, such as the power to control trust investments or the power to use trust income to pay premiums on life insurance policies on the life of the grantor. If these or other specific powers are retained, the trust's income is still considered taxable to the grantor, despite the trust's irrevocable status.

In the case of the Bridge Trust, the trust is very specifically designed to be a Grantor trust.  The Grantor retains full power and authority as both the Trustee and the Primary Beneficiary of the trust.  The Bridge Trust, also specifically states in the Trust the intention to be treated as a Grantor Trust.

Impact on S-Corporation Stock Holding

Grantor Trust Status is Key: For both revocable and irrevocable trusts, the designation as a grantor trust means that for income tax purposes, the grantor is treated as the owner of the trust assets. This treatment allows a grantor trust to hold S-Corporation stock without affecting the S-Corporation's tax status because the IRS disregards the trust entity and treats the grantor as the direct owner of the shares.

Irrevocable Grantor Trusts: If an irrevocable trust qualifies as a grantor trust because the grantor retains certain powers or benefits, it can hold S-Corporation stock, and the tax implications are similar to those of a revocable grantor trust. The income, deductions, and credits from the S-Corporation flow directly to the grantor's individual tax return.

Documentation and Elections

For both revocable and irrevocable grantor trusts holding S-Corporation stock:

No Separate Form 2553 for Trust: As mentioned previously, the trust itself does not file Form 2553 for the S-Corporation election. This form is filed by the S-Corporation upon election or by the trust only if making a specific election (like QSST or ESBT) applicable when the trust's status changes in a way that requires it to be recognized as a separate taxpayer from the grantor.

Consideration of Trust Documents and Elections: It's important for the trust documents to clearly state the powers retained by the grantor that qualify the trust as a grantor trust. In situations where an irrevocable trust might lose its grantor trust status (for example, upon the death of the grantor), planning for the continued eligibility of the trust to hold S-Corporation stock might require specific elections or restructuring of the trust.

Requirements for Holding S-Corp Stock

Filing and Documentation: While specific forms like IRS Form 2553 (for the S-Corp election) may not need to be filed again by the trust, the grantor must ensure that the trust's status as a grantor trust is well-documented and that all applicable tax returns correctly reflect the grantor trust's status and the taxation of the S-Corp's income to the grantor.

Maintaining Eligibility: The trust must ensure that it continues to meet the requirements for being considered a grantor trust throughout its duration. Additionally, if the grantor dies or if the trust's status changes in a way that it no longer qualifies as a grantor trust, the trust must then comply with other S-Corp eligible shareholder types, such as a Qualified Subchapter S Trust (QSST) or an Electing Small Business Trust (ESBT), to maintain the S-Corporation's status.

In conclusion, the irrevocable status of a grantor trust does not, in itself, prevent the trust from holding S-Corporation stock. The key factor is whether the trust is considered a grantor trust for tax purposes, which allows it to bypass certain restrictions on S-Corporation shareholder eligibility. For the Bridge Trust, it is a grantor trust, and thus may hold S-Corp stock with no other special elections or considerations.

If you plan to transfer S-Corp shares, including an LLC taxed as an S-corp, then please let your CPA know that the Bridge Trust is a grantor trust, or forward this article to them.  If you have any questions you may contact us at [e-mail].