Trust as S shareholder.

A trust, to continue as an S shareholder for an extended period of time, must meet the IRS definition of a qualified subchapter S trust (QSST). This requirement's rigidity was highlighted again in IRS revenue ruling 93-31 (IRB no. 1993-17).

In this ruling, a trust holding S corporation stock was to distribute its income to two beneficiaries, with each receiving one-half the trust's income. Likewise, each beneficiary had a one-half share in the corpus (all property the donor included in the trust). Under the separate-share rule of tax code section 663(c), this single trust would be treated as two separate trusts, thus meeting the QSST requirement that there be only one current income and corpus beneficiary for a trust holding S corporation stock.

However, the trust instrument also authorized the trustee to distribute any trust corpus to one beneficiary if necessary for that person's health, education, support or maintenance. Although the likelihood was remote, the mere possibility that corpus from one beneficiary's share of the trust could be distributed to the other beneficiary was sufficient to nullify QSST eligibility and terminate S corporation status.

Observation: The rule prohibiting possible corpus distributions to anyone other than the current income beneficiary during that beneficiary's lifetime is an absolute requirement to maintaining the trust as an eligible S shareholder. This prohibition can be a trap, particularly in the case of testamentary trusts designed to shelter the unified credit amount in an estate.

When S corporation stock is involved, it may be advisable to draft a specific QSST trust for the stock of each beneficiary to ensure continued corporate eligibility for S statue.