What Is a QSST and How Does a Trust Qualify?

A Qualified Subchapter S Trust (QSST) allows a trust to hold stock in an S corporation without jeopardizing the corporation’s tax status. Without this designation, a trust owning S corporation shares could trigger a loss of S corporation status, leading to adverse tax consequences.

Eligibility Criteria

To qualify as a QSST, a trust must meet the requirements of Internal Revenue Code (IRC) 1361(d). It must be a domestic trust, meaning it must be established under U.S. law with a U.S. trustee. A trust formed under foreign jurisdiction or with a non-U.S. trustee does not qualify.

The trust may hold only S corporation stock, aside from cash or assets received from stock distributions or sales. Holding other investments, such as real estate or publicly traded securities, can result in disqualification.

Additionally, the trust must operate under an enforceable trust agreement that complies with state trust laws. If the agreement allows multiple beneficiaries with equal income rights, the trust will not qualify. The IRS may review trust documents to confirm compliance, so trustees should ensure the agreement aligns with QSST requirements.

Single Beneficiary Requirement

A QSST must have only one income beneficiary for its entire existence. This individual is the sole recipient of trust income, and no other person or entity can have a current interest in the earnings from the S corporation stock.

The beneficiary must be a U.S. citizen or resident, as nonresident aliens cannot be S corporation shareholders. If the beneficiary loses U.S. residency status, the trust immediately fails to meet QSST requirements, potentially affecting the S corporation’s tax status. Trustees must monitor any changes in the beneficiary’s residency or citizenship.

If the beneficiary dies, the trust may continue to qualify if it transfers to a new single beneficiary. However, if multiple heirs inherit equal income rights, the trust will no longer meet QSST criteria. Estate planners often structure trusts to ensure a smooth transition that maintains compliance.

Distribution Mandate

A QSST must distribute all of its income annually to the designated beneficiary. This prevents the trust from accumulating earnings, which could alter its tax treatment and jeopardize its status. If a trustee fails to distribute the full income amount each year, the trust risks disqualification.

Under IRC 643(b), QSST income includes dividends, interest, and rental income but generally excludes capital gains unless the trust agreement explicitly requires their distribution. Since capital gains are typically allocated to principal rather than treated as distributable income, trustees must carefully track earnings to ensure compliance.

While the IRS does not specify exact deadlines for distributions, they must be made within a reasonable period after income is received. Many trustees align payments with the trust’s fiscal year-end to simplify reporting. If delays occur due to legal disputes or administrative issues, trustees should document the reasons to mitigate potential IRS challenges.

S Corporation Stock Holdings

A QSST’s ability to hold S corporation stock comes with strict limitations to preserve the corporation’s tax treatment. Unlike other shareholders who may freely transfer shares, a QSST must ensure any stock transfers comply with IRC 1361(b), which restricts eligible shareholders to individuals, estates, and certain trusts. If a QSST transfers shares to an ineligible entity, such as a partnership or a non-qualifying trust, the S corporation could lose its tax status and be taxed as a C corporation, leading to double taxation.

To prevent this, trustees often include provisions in the trust agreement that prohibit unauthorized transfers. Many S corporations also require shareholders to sign buy-sell agreements, which control stock transfers and ensure compliance with IRS rules. These agreements may grant the corporation or other shareholders the right of first refusal before any shares are sold or transferred.

Tax Responsibilities

A QSST is unique in that its income is taxed directly to the beneficiary rather than at the trust level. Under IRC 1361(d)(1), the beneficiary is treated as the owner of the S corporation stock for tax purposes, meaning all income, deductions, and credits associated with the shares pass through to their personal tax return. This differs from Electing Small Business Trusts (ESBTs), where the trust itself is taxed at the highest individual rate.

Since the beneficiary is taxed on their share of the corporation’s income regardless of actual cash distributions, they may face liquidity challenges when paying taxes. To address this, many S corporations adopt tax distribution policies, ensuring shareholders receive enough cash to cover their tax liabilities. Beneficiaries should work with the corporation’s management and tax advisors to plan for potential tax burdens.

Filing the Election

To obtain QSST status, the trust’s beneficiary or trustee must file an election with the IRS. This requires a written statement that includes the trust’s name, employer identification number (EIN), the beneficiary’s name and Social Security number, and a declaration that the trust meets all QSST requirements under IRC 1361(d)(2). The beneficiary must also consent to be treated as the owner of the S corporation stock for tax purposes.

The election must be filed within two months and 15 days after the trust first acquires S corporation shares. If the deadline is missed, the trust will not qualify as a QSST, potentially causing the corporation to lose its S status. In some cases, the IRS may grant relief under Treasury Regulation 301.9100-3, allowing a late election if the failure was due to reasonable cause. However, obtaining such relief requires a detailed explanation and supporting documentation. Once made, the election is irrevocable unless the trust ceases to meet QSST requirements.

Termination Factors

A QSST loses its status if it fails to meet IRS requirements, which can have tax consequences for both the trust and the S corporation. One common reason for termination is violating the single beneficiary rule, such as modifying the trust to allow multiple income beneficiaries. If this happens, the trust ceases to qualify, and the S corporation may be forced to convert to a C corporation, resulting in double taxation.

Another issue arises if the trust fails to distribute all its income annually. If a trustee withholds distributions, even unintentionally, the IRS may determine that the trust no longer qualifies. Additionally, if the trust acquires assets beyond what is permitted under QSST rules, such as real estate or publicly traded securities, it may be disqualified. Trustees must regularly review the trust’s holdings and distribution practices to ensure compliance.