2. Is favorable S corporation status safe after transfer?

If the client for whom estate planning is being done is a shareholder of an S corporation, it is important to ensure that the S corporation’s favorable tax election is not compromised after the transfer and that it does not lose its passthrough tax treatment. Loss of the election would cause tax to be paid at the entity level as a C corporation rather than as a passthrough entity taxed on the shareholder’s income tax returns. This is generally undesirable, as C corporations have potential double taxation. Relief may be available to save the passthrough tax treatment (see Rev. Proc. 2022-19); however, it is better to protect the S corporation election with proper planning.

Generally, estates and trusts can hold S corporation stock for a limited period after death, so timing is important, as is ensuring the ultimate beneficiary is an eligible S corporation shareholder. When S corporation stock is transferred during life, the period to make certain elections is much shorter. In general, only certain trusts can own S corporation stock, and some of these trusts require that special elections be made timely.

Foreign trusts, nonresident aliens, individual retirement accounts, charitable remainder trusts, and other nonqualified trusts are not eligible to hold S corporation stock. To qualify for the favorable tax election, S corporations also limit the total number of shareholders.

Planning point: Make sure there is a plan for S corporation ownership. The rules on trusts owning S corporations can be complex. It is important to work with an estate planning adviser who is familiar with S corporations.