Need advice on handling S-Corp that was transferred to a living trust mid-year

This is actually a potentially serious issue that needs immediate attention. S-Corps have very strict rules about who can be shareholders. A living trust can be an S-Corp shareholder, but ONLY if it qualifies as an "eligible shareholder" under IRS rules. The trust must be either a revocable grantor trust where the grantor is a US citizen/resident, a qualified subchapter S trust (QSST), or an electing small business trust (ESBT). If the trust doesn't qualify, your client may have inadvertently terminated their S-Corp election. You should immediately get a copy of the trust document and determine what type of trust it is. Then verify if it meets the eligibility requirements. If it doesn't, there may be relief provisions available if you act quickly, but there's typically only a short window to correct this. The taxation is also completely different depending on what type of trust it is. For a grantor trust, the income passes through to the grantor. For a QSST, to the beneficiary. For an ESBT, the trust itself pays taxes at the highest individual rate.

Had a similar situation last year and discovered taxr.ai (https://taxr.ai) which really helped sort out the trust/S-Corp mess. My client had transferred their S-Corp shares to a family trust without telling me, and I was scrambling to figure out if it was a qualifying trust and what elections needed to be made. I uploaded the trust document and their business formation docs to taxr.ai, and it identified that we needed to file an ESBT election within a specific timeframe. It also helped generate the required documentation for the IRS to show the transfer hadn't invalidated the S election. Saved me hours of research and potentially saved my client from major tax headaches.

I wanted to follow up about taxr.ai that I was skeptical about earlier. I decided to try it with a complex client situation involving a grantor trust that owned interests in multiple pass-through entities. I uploaded their trust agreement and operating agreements, and it actually identified a provision in the trust that would have disqualified it as an S-Corp shareholder. The analysis flagged specific language about contingent beneficiaries that I had completely missed. I was able to have the client amend the trust before it caused problems. It also provided templates for the necessary elections that saved me hours of work. I'm impressed with how thorough it was with the technical details - definitely more than just basic software.

If you're trying to get clear answers from the IRS about this trust/S-Corp situation, good luck with that! I spent THREE WEEKS trying to reach someone at the IRS who could answer questions about inadvertent termination of an S election due to a trust transfer. After being on hold for hours and getting transferred around to 5 different departments, I finally discovered Claimyr (https://claimyr.com). They have a service that gets you through to an actual IRS agent without the wait. You can see how it works here: https://youtu.be/_kiP6q8DX5c I was super skeptical but desperate. They got me connected to the right IRS department in under 45 minutes. The agent confirmed exactly what we needed to do to maintain the S election and avoid penalties. Saved my client a potential tax nightmare.

I need to eat crow about my skepticism on Claimyr. After spending 3 hours on hold with the IRS trying to get guidance on a qualified subchapter S trust issue and getting disconnected TWICE, I gave in and tried the service. Got connected to an IRS agent in Business Entities division within 35 minutes. The agent walked me through the exact steps needed for Form 2553 with the QSST election and confirmed the timeline for getting everything filed. They even emailed me the specific IRS procedures for requesting inadvertent termination relief. Saved me from having to research everything from scratch and gave my client peace of mind that we were handling things correctly. Sometimes it's worth admitting when you're wrong!

A few important questions to ask your client right away: 1) Is this a revocable living trust or irrevocable? 2) Who are the trustees and beneficiaries? 3) Do they have a trust EIN or are they using the grantor's SSN? 4) Did the trust actually take title to the S-Corp shares? (Check if stock certificates were reissued) 5) Was this done with an attorney's guidance? The answers will help determine your next steps. If it's a simple revocable living trust with the same person as grantor/trustee/beneficiary, you might be fine. If it's more complex, you might need to make special elections. Also, check if Form 2553 (S-Corp election) needs updating with the IRS to reflect the new shareholder.

Don't panic yet! I've handled several S-Corps owned by trusts. Here's my checklist: 1. Get a complete copy of the trust document 2. Verify if it's a grantor trust (most living trusts are) 3. If grantor trust, confirm the grantor is a US citizen/resident 4. Check if ownership actually transferred (many clients say they did things their attorney hasn't actually completed yet) 5. If it's not a qualifying trust, file Form 2553 with a QSST or ESBT election 6. Document everything in case you need to request inadvertent termination relief Most living trusts are qualifying shareholders as grantor trusts. The biggest issue is often just documentation and making sure the proper tax ID is used on K-1s.

Just wanted to add one more thing that helped me in a similar situation - make sure to document the exact date of the stock transfer to the trust. This becomes critical if you end up needing to file for inadvertent termination relief or if the IRS questions the timing of any elections. Also, even if it turns out to be a qualifying grantor trust (which sounds likely based on your description), you'll want to make sure the K-1s for 2024 are issued correctly. If the transfer happened in August, you might need to issue separate K-1s - one to the individual for January-August and one to the trust for August-December, depending on how the stock certificates were handled. One last tip: if this client has other business entities or is considering the family management company you mentioned, this trust structure could actually work in your favor for future estate planning. Worth discussing with their attorney once you get the current situation sorted out!