QSSTs and ESBTs: No Longer Mutually Exclusive

By Melissa A. Abbott, CPA, J.D., Holtz Rubenstein Reminick LLP, New York, NY

Editor: Alan Wong, CPA

S Corporations

Subchapter S corporations are able to have certain trusts as qualified shareholders and retain their S status. Two of those trusts are qualified subchapter S trusts (QSSTs) and electing small business trusts (ESBTs). A trust could elect to be either a QSST or an ESBT, but not both.

Qualified Subchapter S Trust Status

The beneficiary of a QSST is treated as the owner of that portion of the trust that consists of stock in an S corporation—i.e., the current income beneficiary of a QSST is directly taxed as if he or she is the grantor of that portion of the trust. The trust must meet certain terms under Sec. 1361(d)(3) in order to qualify as a QSST:

  • During the life of the current income beneficiary, the trust can have only one income beneficiary of the trust;
  • Any corpus distributed during the life of the current income beneficiary may be distributed only to that beneficiary;
  • The income interest of the current income beneficiary in the trust must terminate on the earlier of the beneficiary’s death or the termination of the trust;
  • Upon the termination of the trust during the life of the current income beneficiary, the trust must distribute all of its assets to such beneficiary; and
  • All the trust’s income is distributed (or required to be distributed) currently to one individual who is a citizen or resident of the United States.

Although a QSST by definition can have only one current income beneficiary, it is possible to have multiple beneficiaries, provided separate shares in the trust are created with respect to each beneficiary. Sec. 1361(d)(3) provides that a substantially separate and independent share of a trust will be treated as a separate trust. Therefore, a single trust may technically have multiple beneficiaries and still qualify as a QSST as long as each beneficiary has a separate and independent share in the trust.

In Rev. Rul. 93-31, the IRS ruled that a separate share of a trust cannot qualify as a QSST if there is even a remote possibility that the trust corpus will be distributed during the current income beneficiary’s lifetime to someone other than the current income beneficiary.

The possibility of multiple or ineligible beneficiaries after the death of the current beneficiary does not disqualify the trust during the current income beneficiary’s lifetime.

Electing Small Business Trust Status

Unlike a QSST, an ESBT can have multiple beneficiaries, and trust income can be accumulated or sprinkled among multiple beneficiaries.

Under Regs. Sec. 1.641(c)-1, an ESBT is treated as two separate trusts for purposes of determining its tax liability. Those two separate trusts are referred to as the S portion and the non-S portion. The ESBT’s S portion consists of S corporation stock and is not treated as owned by the grantor or any other person. The S portion does not factor into the computation of the trust distributable net income (DNI). The taxable income of the S portion is determined by taking into account only the items of income, loss, deduction, or credit attributable to the S portion. The S portion is taxed entirely at the highest trust rate.


A QSST can be preferable to an ESBT because the income flows through and is taxed directly to the beneficiary. An ESBT’s taxable income is trapped within the trust for tax purposes, even if it is actually distributed out to the beneficiaries. An ESBT also gets taxed automatically at the highest trust tax rate and is unable to take advantage of the graduated rate structure at all. This is a definite disadvantage for an ESBT that has very little or no other taxable income aside from the income from the S portion of the trust.

Letter Ruling 201122003

Finally, there is hope that a trust that has made a qualifying ESBT election can treat certain separate shares as eligible for a QSST election. In Letter Ruling 201122003, the taxpayer requested a ruling regarding a trust that had already made a valid ESBT election. The taxpayer requested that:

  • Each income beneficiary’s share in the trust be considered substantially separate and independent within the meaning of Sec. 663(c) such that each share be treated as a separate trust for purposes of Secs. 1361(c) and (d);
  • Each separate share qualifies as a QSST under Sec. 1361(d)(3); and
  • Each income beneficiary can make an election under Sec. 1361(d)(2) to have the separate trust treated as a QSST, and the shares that do not elect to be treated as a QSST may continue to be treated as an ESBT.

The IRS concluded that each beneficiary’s share of the trust constituted a separate and independent share of the trust and that, provided the income is distributed currently, each separate share of this particular trust qualified as a QSST. The IRS further concluded that the revocation of the ESBT election for the separate shares will have no effect on the current ESBT election for the separate shares of the remaining income beneficiaries.


Under Letter Ruling 201122003, if a current ESBT allows for separate and independent trust shares under the trust document, a trust may be treated as both an ESBT and a QSST. Certain separate shares under the trust may separately elect and qualify for QSST status, while the remaining shares of the same trust can retain their ESBT status. This ruling opens the door for additional planning for gifts of S corporation stock to younger generations. For example, if separate shares are permitted under a trust document, income can be accumulated until a beneficiary reaches a certain age (ESBT election) and then distributed and taxed to the beneficiary (QSST election), allowing for much more flexibility.


Alan Wong is a senior manager at Holtz Rubenstein Reminick LLP, DFK International/USA, in New York, NY.

For additional information about these items, contact Mr. Wong at (212) 697-6900, ext. 986, or awong@hrrllp.com.

Unless otherwise noted, contributors are members of or associated with DFK International/USA.

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