When S corporation (S corp) shareholders die, the transfer of their shares is governed by their estate plan, will, or applicable law. The post-death transfer, if not carefully considered, may pass to a potentially ineligible shareholder, leading to the termination of an S corp election as of the date the shares are transferred. Additionally, a transfer could run afoul of the 100-shareholder rule and similarly cause an inadvertent termination of an S corp election. After termination, the corporation cannot re-elect S corp status for five years unless it obtains IRS consent or seeks inadvertent termination relief. Therefore, it’s essential for remaining shareholders, executors, and trustees to understand the rules and strategies to maintain S corp eligibility after an owner’s death.
Planning Considerations Around the Death of a Shareholder
Review the Estate and any Succession Plan
Understand to whom the shares will pass and whether those recipients are eligible S corp shareholders. Consider using a buy-sell agreement to ensure that ownership will be transferred to eligible S corp shareholders and control the number of additional shareholders resulting from the transfer.
Identify Eligible Successor Shareholders
All transfers of S corp stock require due diligence. In general, the following are common successors under a shareholder’s estate plan.
Estate
If the shares are held by the decedent’s estate, the estate itself is eligible, but this period is temporary (the “administration period”). Upon completion of the administration, the shares will be distributed to the heirs or to a trust.
Under Reg. §1.641(b)-3(a), the period of administration is the period required by the administrator or executor to perform the ordinary duties of administration, such as collecting assets and paying debts, taxes, legacies, and bequests. The determination is based on the facts and circumstances of the estate’s administration, and the period may be longer or shorter than the period specified under the applicable local law for the settlement of estates.
Grantor Trust
Grantor trusts are eligible shareholders as long as the grantor or beneficiary is otherwise eligible. This type of trust is treated as owned by an individual grantor or an individual beneficiary, whereby the grantor or beneficiary retains control over the assets or income. The deemed owner (grantor or beneficiary) must be a U.S. citizen or resident.
Irrevocable Trust (Inter Vivos)
S corp stock may be transferred to an inter vivos irrevocable trust prior to death through gifting, sale of stock, or issuance of new shares. For an inter vivos trust to be considered an eligible S corp shareholder, a valid QSST or ESBT election must be made timely (see discussion on timing below).
Irrevocable Trust (Testamentary)
Trusts established by a decedent’s will and are created as part of the administration of the estate. Such a trust is eligible to be a shareholder for only two years following the transfer. If the trust qualifies, it can elect QSST or ESBT status prior to the end of the two-year window.
Individual Heirs
Individuals (U.S. citizens or residents) are allowable shareholders.
Check for Irrevocable Trust Eligibility
If the shares will be held in an irrevocable trust, confirm that the trust qualifies as eligible under any of the following:
Qualified Subchapter S Trust (QSST)
The trust must have only one income beneficiary, and that beneficiary must be a U.S. citizen or resident. The beneficiary must make a QSST election within 2.5 months of the transfer. QSST elections are made on IRS Form 2553.
Simple Example to Demonstrate Timing
Taxpayer owns S corp stock. The Taxpayer’s will leaves the S corp shares to an irrevocable trust (QSST eligible) for the benefit of the Taxpayer’s child. The S corp stock is transferred to the trust on May 15, 2026. The QSST election would be due by July 30, 2026.
Electing Small Business Trust (ESBT)
Trusts that have more than one eligible beneficiary can elect to be ESBTs. The trustee must make the election within 2.5 months of transfer. ESBT elections are made on IRS Form 8869.
Crummey Trust
A trust with “Crummey power” (i.e., a 30-day window during which a beneficiary can withdraw any contribution that was made to the trust) may cause the sole beneficiary to be treated as the owner of the entire trust for purposes of the grantor trust rules.
Confirm the Potential Change in Shareholder Count (including the application of attribution rules)
For purposes of the S corp shareholder limit, family members and their estates may be treated as a single shareholder. A Family Member is defined as all lineal descendants of a common ancestor, as well as the spouses, or former spouses, of these individuals. This aggregation rule also applies to the income beneficiary of a QSST and each current beneficiary of an ESBT.
Coordination with Executors and Trustees
Heirs and beneficiaries, and their tax advisors, should discuss the importance of timely filing QSST or ESBT elections with executors and trustees, as these elections can easily be missed.
IRS Relief for Inadvertent Terminations
General Relief
Under Section 1362(f), the IRS may grant relief for inadvertent termination if the S corp and shareholders acted reasonably and in good faith and promptly corrected the error after discovery. Relief is obtained through submission and approval of a Private Letter Ruling (PLR) request.
Missed Election Relief
Alternative relief provisions are available under Rev. Proc. 2013-30 for those S corps whose termination results from failing to make a timely QSST or ESBT election, provided the failure was inadvertent. The corporation and relevant parties must file the proper QSST or ESBT election forms (with required statements) and provide notification to the IRS service center, as outlined in the Revenue Procedure. The benefit is that if eligible, the relief is automatic and no PLR is required.
To qualify for late election relief under Rev. Proc. 2013-30, the requesting entity must establish all of the following:
Intent
The Requesting Entity intended to be classified as an S corp, intended the trust shareholder to be an ESBT, intended the trust shareholder to be a QSST, or intended to treat a subsidiary corporation as a QSub as of the effective date.
Sole Cause of Failure was late election
The failure to qualify as an S corp, ESBT, QSST, or QSub as of the effective date was solely due to the failure to timely file the required election (e.g. ESBT election, QSST election, etc.).
Reasonable Cause
The entity must demonstrate reasonable cause for failing to make the election timely.
In cases involving an inadvertently invalid S election or an inadvertent termination resulting from failure to make a timely ESBT or QSST election, the taxpayer must show the failure was inadvertent, and the S corp and affected shareholders or trust beneficiaries acted diligently to correct the error once discovered.
Consistent Reporting
The entity and all shareholders must have reported income and filed returns consistently with S corp status for the year the election should have taken effect and for all subsequent years.
Timeliness of Relief Request
The request for relief must generally be made within 3 years and 75 days of the intended effective date of the election. Certain entities may qualify for the 3-year and 75-day rule if additional requirements are met under the Revenue Procedure.
If the entity qualifies and files timely in accordance with Rev. Proc. 2013-30, the IRS can grant late election relief. If the entity does not qualify under the Revenue Procedure, its only alternative option is to request a PLR.
If you have any questions regarding the potential inadvertent termination of an S corp’s election, through a shareholder’s death or otherwise, contact your CBIZ tax professional.
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