Qualified Subchapter S Trusts (QSSTs) are one of the limited set of trusts that are eligible S corporation shareholders upon the election of the beneficiary to treat the trust in this manner. However, such trusts must have terms that conform to requirements imposed by the law in order for the trust to be eligible, upon the beneficiary’s election, to be treated as such a trust.
In PLRs 201614002 and 201614003 the taxpayers were asking the IRS whether a binding, nonjudicial settlement under state law regarding the trust’s language could be used to solve what otherwise appeared to be problems with the terms of trusts for which an S election was desired.
As the PLRs note:
Section 1361(d)(3) defines the term “qualified subchapter S trust” as a trust all of the income (within the meaning of section 643(b)) of which is distributed (or 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 during the life of the current income beneficiary there shall be only one income beneficiary of the trust; any corpus distributed during the life of the current income beneficiary may be distributed only to such beneficiary; the income interest of the current income beneficiary in the trust shall terminate on the earlier of such beneficiary’s death or the termination of the trust; and upon the termination of the trust during the life of the current income beneficiary, the trust shall distribute all of its assets to such beneficiary.
In the trust that lead to this ruling the trust had a number of provisions that appeared to potentially run afoul of these restrictions. Specifically, the following provision, which references the beneficiary’s (the child) descendants appeared to raise concerns:
Article Seventh, Section 3 of the trust agreement further provides that "[t]he trustee may also pay to the child such sums from the principal of [Trust] as the trustee deems necessary or advisable from time to time for the health, maintenance in reasonable comfort, education (including postgraduate) and best interests of the child and his descendants, individually and as a group, considering the income of each of them from all sources known to the trustee. No payment made for a descendant of the child shall be charged against the share hereinafter provided for the descendant or his ancestor or descendants."
The concern appeared to be that this paragraph might violate the “one beneficiary” requirement, assuring that during that beneficiary’s lifetime the only distributions that would be made would be to that beneficiary. Since the trustee has to consider the needs of the descendants of the beneficiary in invading corpus, it could be argued that such distributions would, while paid to the child, be indirect distributions to the grandchild.
The governing law of the state in question allowed for all of the interested parties (trustee, beneficiaries, etc.) to enter into a “binding, non-judicial agreement” that deals with the validity, interpretation or construction of terms of the trust. Under the terms of the agreement the following items were agreed to:
1. That the power of the trustees to distribute the principal of Trust pursuant to Article Seventh, Section 3 of the trust agreement is limited to a distribution to B, and is not for the benefit of any other person during the life of B.
2. That the terms of the trust agreement governing Trust do not authorize or permit distributions of principal to any descendant of B, directly or indirectly, during the life of B, and that principal distributions from Trust may only be made for B’s benefit.
3. That the provisions of Trust do not create, nor did A intend to create, any right, claim or cause of action in any such descendant, as against B or the trustees, to compel or require B or the trustees to pay over any part or all of a principal distribution to such descendants, or any of them, whether or not the trustees took into account the health, maintenance in reasonable comfort, education and best interests of those descendants in determining the amount of the principal distribution.
The trust now looked for the IRS’s blessing that the provisions of the trust, as agreed upon by this agreement that was binding under state law, would qualify it for QSST status.
The IRS held that the trust, when considering the agreement, did qualify for election to be treated as a Qualified Subchapter S Trust.