REVENUE RULE 92-48

1992-1 C.B. 301, 1992-26 I.R.B. 7.

Internal Revenue Service
Revenue Ruling

QUALIFIED SUBCHAPTER S TRUSTS

Published: June 29, 1992

Section 1361 - S Corporation Defined

26 CFR 18.361-1; Election to treat qualified subchapter S trust as a trust described in section 1361(c)(2)(A)(i). (Also Section 664; 1.664-2.)

QUALIFIED SUBCHAPTER S TRUSTS. A trust that qualifies as a charitable remainder trust under section 664 of the Code cannot be the subject of a "qualified subchapter S trust" election under section 1361(d)(2).

ISSUE

Can a trust that qualifies as a charitable remainder trust under section 664 of the Internal Revenue Code be the subject of a "qualified subchapter S trust" (QSST) election under section 1361(d)(2)?

FACTS

X is a small business corporation that made a valid election in 1985 to be an S corporation. In 1990, A, an individual who owned shares of stock in X, transferred some of those shares to a valid charitable remainder unitrust, TR, described in section 664(d)(2) of the Code. Under the terms of TR, the trustee is required to pay annually to B, an individual and a citizen of the United States, for life an amount equal to the lesser of (1) the amount of TR's income (determined under section 643(b)) for the taxable year, or (2) 12 percent of the net fair market value of TR's assets valued as of the first day of the taxable year. If the amount of TR's income for the taxable year exceeds the amount determined under (2), then the payment to B is to include the excess income to the extent that the aggregate of the amounts paid in prior years to B was less than 12 percent of the aggregate net fair market value of TR's assets for those years. At B's death, the trustee must distribute all of TR's remaining principal and income, other than any amount due B or B's estate, to Y, an organization described in section 170(c). Upon A's transfer of the X stock to TR, B filed a QSST election with respect to TR under section 1361(d)(2).

LAW AND ANALYSIS

The tax treatment of charitable remainder trusts is governed by subpart C of part I of subchapter J of the Code (sections 661 through 664), whereas the tax treatment of QSSTs is governed by section 1361 and, by cross reference, subpart E of part I of subchapter J (sections 671 through 679). The rules under subpart C can require tax results that are incompatible with those required by the rules under subpart E.

The rules governing the taxation of charitable remainder trusts are contained in section 664 of the Code, a section within subpart C of part I of subchapter J. Section 664(a) states that notwithstanding any other provision of subchapter J, the provisions of section 664 shall, in accordance with the regulations, apply in the case of a charitable remainder trust. In general, under section 664(d), a charitable remainder trust is a trust pursuant to which an annuity or unitrust amount, determined under a specified formula, is payable at least annually for either the life or lives of a named individual or individuals or for a term of years (not to exceed 20 years). Section 664(b) provides rules for characterizing the distributed amounts in the hands of the income beneficiaries (e.g., as ordinary income, capital gain, or distribution of corpus). Under sections 664(d)(1)(B) and 664(d)(2)(B), no amount other than the annuity or unitrust amount may be paid to or for the use of any person other than an organization described in section 170(c). Any amount earned by the trust in excess of the amount distributed to the beneficiaries is accumulated for eventual payment to or for the use of an organization described in section 170(c). The remainder interest in the trust is payable on the termination of the annuity or unitrust payments.

Section 1361(b)(1)(B) of the Code permits only individuals, estates, and trusts described in section 1361(c)(2)(A) to be shareholders of S corporations. Under section 1361(d)(1)(A), a QSST is treated as a trust described in section 1361(c)(2)(A) and therefore is a permissible S corporation shareholder. The rules governing the taxation of QSSTs are provided by section 1361 and, by reference, sections 671 through 679 (subpart E of part I of subchapter J).

Section 1361(d)(3) of the Code defines the term "qualified subchapter S trust." For a trust to meet that definition, all of the income (within the meaning of section 643(b)) of the trust must be distributed (or be required to be distributed) currently to one individual who is a citizen or resident of the United States. In addition, the terms of the trust must require that (i) during the life of the current income beneficiary there is only one income beneficiary of the trust; (ii) any corpus distributed during the life of the current income beneficiary may be distributed only to that beneficiary; (iii) the income interest of the current income beneficiary in the trust terminates on the earlier of such beneficiary's death or the termination of the trust; and (iv) upon the termination of the trust during the life of the current income beneficiary, the trust must distribute all of its assets to the beneficiary.

Under section 1361(d)(2)(A) of the Code, QSST status must be elected by the beneficiary of the trust (or the beneficiary's legal representative). If a QSST election is made, section 1361(d)(1)(B) provides that for purposes of section 678(a), the QSST beneficiary is treated as the owner of that portion of the trust that consists of stock it an S corporation. Section 671 provides that, where it is specified in subpart E of part I of subchapter J of the Code that the grantor or another person is to be treated as the owner of any portion of a trust, the items of trust income, deductions, and credits attributable to that portion are included in computing the taxable income and credits of the grantor or other person. Any remaining portion of the trust is subject to subparts A through D of part I of subchapter J.

Section 678(a) of the Code (which, under certain circumstances, treats a person other than a grantor as the owner of a trust) is within subpart E of part I of subchapter J (sections 671 through 679). Thus, a beneficiary who makes a QSST election agrees, pursuant to section 678(a), to be treated as the owner of the trust to the extent that the trust assets consist of S corporation stock and hence agrees to be taxed under section 671 to that extent.

To the extent that a QSST's assets consist of S corporation stock, the QSST's beneficiary is treated as the owner of a grantor trust under subpart E. This tax result is incompatible with the rule that a charitable remainder trust function exclusively under section 664 of the Code.

Moreover, other rules of subpart E are inconsistent with the rules of section 664, in particular the rules for how beneficiaries are taxed on both distributed and undistributed amounts of trust income.

On a given set of facts, the character and amount of trust income taken into account by the beneficiary could be the same whether the trust was governed by the charitable remainder trust rules or the QSST rules. However, the identity of treatment under such circumstances would be coincidental. The incompatible tax treatment of trust income under subparts C and E of part I of subchapter J precludes the beneficiary of a charitable remainder trust from making a valid QSST election under section 1361 of the Code.

The QSST election filed by B is invalid. Accordingly, as TR is an ineligible shareholder, X's S election is terminated under section 1362(d)(2) of the Code as of the date of A's transfer of the X stock to the trust. The transfer has no effect on the validity of TR's status as a charitable remainder trust.

HOLDING

A trust that qualifies as a charitable remainder trust under section 664 of the Code cannot be the subject of a "qualified subchapter S trust" election under section 1361(d)(2).

If stock of an S corporation is transferred to a charitable remainder trust (other than a trust described in section 1361(c)(2)(A)(iii) of the Code), the corporation's S election is terminated because the charitable remainder trust is not an eligible shareholder. The corporation may be eligible for relief from inadvertent termination of its S election under section 1362(f).

DRAFTING INFORMATION

The principal author of this revenue ruling is David McDonnell of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling, contact Mr. McDonnell on (202) 377- 9470 (not a toll-free call).

Rev. Rul. 92-48, 1992-1 C.B. 301, 1992-26 I.R.B. 7.