by Paul Hicks
As estate planners, we often see clients, who have as a significant part (if not most) of the value of estate, their closely held family business. Many times the business is being operated as an “S” corporation. These clients face at least two issues. The first issue is the problem of passing the family business to the next generation and not being forced to liquidate the assets to pay any estate tax due. The second issue is needing to use the value of the business to fund a credit shelter trust at the death of the first spouse in an attempt to maximize the use of both spouse’s unified credit amount in order to reduce estate taxes. Therefore, we can be faced with a planning opportunity that requires placing “S” corporation stock in a credit shelter trust. This of course raises the issue in regard to the restrictions on “S” corporation stock and the types of allowable shareholders.
If the goal is, at the death of the second spouse, to liquidate or sell the business to the next generation, the estate temporarily holding or transferring the “S” stock is not an issue. The Internal Revenue Code (the “Code”) allows for an estate to hold “S” stock while the business is being wrapped up or the estate administered. However, a trust as shareholders is another issue. The Code limits the types of trusts that can be a shareholder of “S” stock.
One way to avoid the problem of a trust holding the stock is for the trust to be a Qualified Sub-Chapter S Trust (“QSST"). To be eligible for QSST status, a trust must satisfy the following requirement:
- All the trust income is required to be distributed currently to a single income beneficiary;
- The current income beneficiary must be a US citizen or resident;
- The trust instrument requires that, during the life of the current income beneficiary, there will be only one current income beneficiary
- The principal of the trust can only be distributed to the current beneficiary during his or her lifetime;
- The trust provides that the income interest terminate on the earlier of the beneficiary’s lifetime or the termination of the trust; and
- The trust requires that if it terminates during the life of the current income beneficiary, he or she receives all the trust assets.
In addition to satisfying the requirements, the current income beneficiary must make a timely QSST election. Generally, the election must be made within two months and 16 days after the stock is transferred to the trust.
Fortunately, many of the trusts we use for estate planning purposes lend them self to qualifying as QSSTs. Trusts such as 2056(b) General Power of Appointment Marital Deduction trust, QTIP trusts, 2503(c) trusts for a minor, Unified Credit Shelter trusts without sprinkle provisions are easily modifiable to satisfy the requirements for a QSST. Therefore, with relatively little extra planning efforts the same trusts we normally use for estate planning purposes can qualify for the QSST elections. Besides insuring the actual provisions of the trust satisfy the requirements, I suggest language be added to the trustee powers to ensure the election can be made.
In conclusion, whether you are faced with an estate that needs to ensure the future of the family business continues in a trust or just the possibility that the a credit shelter trust may need to be funded to ensure the proper estate tax planning is accomplished, it would be wise to consider ensuring that the trust can qualify for a QSST if necessary. This is a small effort that could reap big rewards of insuring a pass through income tax treatment for the future shareholders.
Paul L. Hicks is an associate in the Parkersburg office and a member of the Tax Group. He focuses his practice in the areas of tax, estate planning and administration, asset protection planning, elder law and Medicaid planning, guardianship and conservatorship proceedings, with additional experience in general business, real estate and natural resources, and equine law.
Paul received his law degree from the West Virginia University College of Law, and earned his Bachelor of Science degree in Business Administration, with an emphasis in accounting, from West Virginia University. He is a member of the West Virginia Bar Association, The Ohio Bar Association, the Wood County Bar Association and is licensed to practice in West Virginia and Ohio and before the U.S. District Court for the Southern District of West Virginia.
Contact Information
phicks@bowlesrice.com
T: (304) 420-5510
F: (304) 420-5587
The author presents these materials with the understanding that the information provided is not legal advice. Due to the rapidly changing nature of the law, information contained in this publication may become outdated. Anyone using these materials should always research original sources of authority and update this information to ensure accuracy when dealing with a specific matter. No person should act or rely upon the information contained in this publication without seeking the advice of an attorney.
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