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The IRS issued a revenue procedure designed to ease the task of converting trusts back and forth between qualified subchapter S trust (QSST) status and an electing small business trust (ESBT) status.

As a general rule, trusts cannot qualify to own S corporation stock, but there are two exceptions. A trust can elect to be a QSST if it has only one beneficial owner, all corpus distributions made during the life of the beneficiary are made to the beneficiary alone, and all income is distributed to the beneficiary.

An ESBT may have more than one current income beneficiary, but all beneficiaries must be individuals, estates, or certain tax-exempt entities, and no interest in the trust may be acquired by purchase. The advantage of an ESBT is that S corporation income and distributions may be sprinkled among beneficiaries. The disadvantage of an ESBT is that the pass-through income from the S corporation is taxed at the maximum individual rates. For these special trust provisions to apply to either a QSST or an ESBT, the trust must file an election. A trust cannot qualify as both a QSST and an ESBT at the same time.

The recently published ruling sets out the conditions and procedures a trust must go through to change its status either from a QSST to an ESBT or visa versa.

To change a QSST to an ESBT, the trust must meet all the ESBT requirements set out in IRC section 1361, the trustee and beneficiary must make the election, the trust cannot have converted from an ESBT to a QSST within the preceding 36 months, and the election may only be retroactive for 2 months and 15 days. The ESBT election should state at the top of the document, "ATTENTION ENTITY CONTROL­CONVERSION OF A QSST TO AN ESBT PURSUANT TO REV. PROC. 98-23." Similar requirements are set up to change an election of an ESBT to a QSST.*

Source: Rev. Proc. 98-23, 1998-10 I.R.B. __ (March 9, 1998).

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