Trick or Treat? S Corporations and Estate Planning

November 2nd, 2015 by JBWK

Submitted by Rebecca Shwayder Aman

Small or closely held businesses can take one of several forms, including limited liability companies (“LLCs”), partnerships and S corporations (corporations which have made a special tax election with the IRS). To certain types of businesses, an S corporation offers the best of both worlds. Like LLCs and partnerships, an S corporation is not subject to the double taxation imposed on regular “C” corporations.
Unlike LLCs and partnerships, however, an S corporation owner, who is active in the business, does not have all of his or her income subjected to income and employment taxes. Rather, the shareholder should be paid a fair market wage, which is subject to income and employment taxes, but any income above and beyond the wage simply is subject to income taxes.

Obviously, an S corporation can be the right choice of entity for a small or closely held business. With these tax-preferred “treats,” however, comes the risk of estate and business succession planning “tricks.” Only certain individuals, estates and types of trusts may be shareholders of an S corporation. If a prohibited individual, trust or other entity ever becomes an owner, the S election may be declared null and void by the IRS, and the business income taxed twice, at the corporate level and also to the shareholders.

Allowable S corporation shareholders include:
1) Individuals who are United States citizens or residents
2) Estates of a deceased S corporation shareholder, but only for a reasonable time period for administration
3) Certain types of Grantor Trusts, which are trusts treated as owned by a U.S. citizen or resident (for example, your revocable trust during your life). A grantor trust also continues to qualify after the grantor’s death for a 2-year period beginning on the date
of the grantor’s death.
4) Testamentary Trusts, which are trusts established under a will, but which qualify only for a 2-year period beginning on the date the S corporation shares are transferred to the trust.
5) Voting trusts
6) Qualified Subchapter S Trusts (QSSTs), which may only have one beneficiary
7) Electing Small Business Trusts (ESBTs)

Individuals who own shares in an S corporation should seek the advice of an attorney familiar with S corporations for their estate planning needs. If your estate plan includes the use of an ongoing trust for loved ones following your death, an experienced estate planning attorney can help you structure your plan and include special language in your documents so that the trust may qualify as a Qualified Subchapter S Trust (QSST) or an Electing Small Business Trust (ESBT).

Even if your estate plan simply involves the use of a will or revocable living trust, your estate planning attorney may want to include special language in your documents to reflect your ownership of S corporation shares and to advise your family to seek legal assistance as soon as possible following your death, so that any S corporation shares may be distributed or qualifying trusts established within the limited time periods. The estate planning attorneys of Jones, Blechman, Woltz & Kelly, P.C., routinely assist clients with planning for S corporation ownership interests.

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