Trusts can be an integral part of estate planning, offering tax advantages and giving individuals the ability to distribute their assets according to their desires. An individual who holds shares in an S corporation and who is considering gifting stock as part of planning their estate may wish to carefully consider the types of trusts available. In our article, Trust Types As An S Corporation Shareholder, we discussed several types of trusts that can serve as an S corporation shareholder. In this article, we will provide a deeper comparison between two types: the electing small business trust (ESBT) and the qualified Subchapter S trust (QSST).
There are similarities and differences between the trusts including in areas such as beneficiary rules and tax requirements.
QSSTs, ESBTs, Beneficiaries and Income
Because S corporations are limited to 100 or fewer shareholders, understanding the difference between the treatment of beneficiaries by both trusts is crucial.
- A QSST trust has a single income beneficiary who serves as the shareholder in the corporation. However, the QSST still serves as owner of the trust with any gains or losses recognized by the S corporation shares belonging to the trust and not the beneficiary. Annually, all income from the trust is distributed to the beneficiary. The beneficiary also elects the QSST trust (rather than another type of trust) to hold shares of the S corporation with a separate election required for each corporation held in trust.
- By contrast, an ESBT can have multiple beneficiaries including not only individuals but also estates and certain types of charitable entities. Each beneficiary will serve as a separate shareholder in the corporation and receives income from the trust. Income in an ESBT may also be accumulated over a period of time without a required distribution though this is not a requirement and does not include dividends and capital gains, which must be distributed.
QSSTs, ESBTs and Taxation
The biggest difference between the two types of trusts regarding taxation is that the income beneficiary of a QSST reports the trust income and expenses on his/her individual return while the ESBT reports income and expenses on Form 1041, U.S. Income Tax Return for Estates and Trusts. As a result, the QSST beneficiary is taxed at the individual tax rate while ESBT beneficiaries are taxed at the trust rate, which is typically higher. Some dividends and capital gains from the ESBT may pass through to the individual for tax purposes, which can relieve the higher tax burden.
While both types of trusts are vehicles for holding stock from an S corporation, an ESBT has another differentiator, which is that interest in the trust cannot be purchased but must be gifted or received through an inheritance or some similar transaction.
Making the Decision: QSST or ESBT?
Selecting either a QSST or ESBT to hold your S corporation stock and serve your financial goals can be a complex task requiring knowledge of how each trust works and an understanding of the tax implications. Making the right decision can often benefit from the advice and expertise of an experienced estate planner or tax accountant.
For more information or for assistance, please contact Tom Burton via our online contact form.
Councilor, Buchanan & Mitchell (CBM) is a professional services firm delivering tax, accounting and business advisory expertise throughout the Mid-Atlantic region from offices in Bethesda, MD and Washington, DC.
