PKF O'Connor Davies Accountants and Advisors
PKF O'Connor Davies Accountants and Advisors

Trusts Can be Shareholders of S Corporations … Sometimes

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July 21, 2025

Your Guide to Navigate the S Corp Waters and Prevent Double Taxation

By Bhakti Shah, JD, CPA, Partner and Donna Perrette, JD, CPA, Manager


Key Takeaways

  • Certain trusts can qualify as S corporation shareholders under specific Internal Revenue Service (IRS) requirements.

  • Qualified Subchapter S Trust (QSST) and Electing Small Business Trust (ESBT) elections have distinct tax implications that require careful consideration.

  • Failing to meet trust eligibility rules may risk S corporation status and lead to double taxation.

The recent tax reforms of the One Big Beautiful Bill Act (OBBBA) are causing estate planners to re-evaluate current trust structures. Although the OBBBA does not alter the eligibility rules governing the types of trusts that are permitted as S corporation (S Corp) shareholders, the act does encourage strategic trust planning as it relates to the permanent increase in estate, gift and generation-skipping transfer (GST) tax exemptions and the stabilization of individual and trust income tax rates. Understanding the nuances of Qualified Subchapter S Trusts (QSSTs), Electing Small Business Trusts (ESBTs) and grantor trusts has become even more critical for effective tax planning.

A primary benefit of an S Corp is having a tax status that allows taxable income, losses, credits and deductions to pass through to shareholders, thus preventing double taxation.

While, generally, only individuals can be owners/holders of an S Corp, some trusts can also qualify as shareholders. As part of estate planning, many individuals therefore choose to place S Corp stock into trusts. While advantageous, we caution that great care must be taken if you choose this strategy.

First, only certain types of trusts are eligible to become S Corp shareholders. There are then unique nuances and requirements regarding each trust type so as not to jeopardize its tax status. To navigate the S Corp shareholder waters, we offer the information below as your guide to skillfully pursue this strategy.

Eligible Trusts … and The Rules You Must Know to Navigate

Eligible trusts include grantor trusts, certain testamentary trusts, voting trusts, QSSTs and ESBTs. The following table details the specific nuances and requirements of each trust type for it to qualify as an S Corp shareholder.

Trust Type

 Description

Requirements to Qualify as an Eligible Shareholder

 Important Details

Grantor Trust

A trust where the person who creates it (the grantor) is treated as the owner of the trust assets for tax purposes, even though the trust owns them.

A grantor trust is an eligible shareholder if the grantor is a U.S. citizen or resident.

If the grantor of the trust dies, the trust continues to qualify as a permissible shareholder for two years following the date of death.
Unlike ESBTs and QSSTs, no election is necessary for a grantor trust to be an eligible shareholder of an S Corp.

Voting Trust

A trust created primarily to exercise the voting power of the S Corp stock. The trustee has the irrevocable right to vote on behalf of the group of shareholders. 

Each beneficiary of the trust must be treated as a separate S Corp shareholder for their proportionate share of the trust’s stock.The beneficial owners must be U.S. citizens or residents.

Testamentary Trust

A trust created under the will of a decedent.

Testamentary trusts that receive S Corp stock pursuant to the terms of a will are permitted to hold the stock for a period of two years. At the expiration of the two-year period, the stock must either be distributed or the trust must elect to become a QSST or ESBT to maintain S Corp status.

Qualified Subchapter S Trust (QSST)

A QSST is specifically created to hold S Corp stock.

 

There are five conditions for a trust to qualify as a QSST:

  • The trust has only one income beneficiary and that beneficiary is a U.S. citizen or resident.
  • All of the income of the trust  is or is required to be distributed currently to the one income beneficiary.
  • Any corpus distributions, including terminating distributions, must also go to the same one beneficiary if made during the beneficiary’s lifetime.
  • The income interest of the beneficiary must terminate on the earlier of the beneficiary’s death or the trust’s termination.
  • An election to be treated as an eligible S Corp shareholder is made separately for the stock of each S Corp held by the trust.
Once a QSST election is made, it is revocable only with the consent of the Internal Revenue Service (IRS), so thorough consideration must be made prior to making the election.

The key advantage of a QSST is that the income beneficiary is treated as the owner of the S Corp stock for income tax purposes.

This means that all income, deductions and credits flow directly to the beneficiary’s personal tax return, potentially achieving tax savings if the beneficiary is in a low tax bracket.

Electing Small Business Trust (ESBT)

A special type of trust that is permitted to own stock in an S Corp, making an ESBT a permissible S Corp shareholder.

The election to be treated as an ESBT must be filed within two months and 16 days from the date the S Corp stock was transferred to the trust.

An ESBT can potentially allow for more flexibility than a QSST because an ESBT is allowed to have multiple beneficiaries and can provide that the income be distributed or accumulated.

An ESBT is permitted to have individuals, estates, charitable entities and certain government entities as permissible beneficiaries.
Although it allows greater flexibility, the disadvantage of an ESBT is that the trust is taxed on all of the S Corp income at the highest individual rate, irrespective of whether income distributions were made.

Skill is Required to Navigate the Winding Waters of S Corp Shareholders

If you are responsible for overseeing a qualifying trust, it’s imperative that you closely monitor its status when S Corp shares are involved. If these trusts do not meet their respective Internal Revenue Code (IRC) regulations, the S Corp election for the underlying entity may be at risk. The consequence of a broken S Corp election is that the entity would become a C Corporation, leading to double taxation.

We Can Help

PKF O’Connor Davies has the tax specialists on hand to help you understand the rules surrounding S Corp shareholders and the resulting tax implications. We welcome the opportunity to answer any questions you may have related to this topic or any other accounting, audit, tax or advisory matter. Please reach out to your client service team or:

Bhakti Shah, JD, CPA
Partner
bshah@pkfod.com

Donna Perrette, JD, CPA
Manager
dperrette@pkfod.com