New Tax Rules for U.S. Trusts with Beneficiaries

calendar iconJanuary 4, 2021

As a result of the Tax Cuts and Jobs Act (“TCJA”), a non-resident alien (“NRA”) is now permitted to be a potential current beneficiary of an Electing Small Business Trust (“ESBT”). Additionally, the IRS recently issued final regulations confirming that S corporation income will continue to be subject to U.S. federal income tax even when an NRA is determined to be the owner of the ESBT. Specifically, the allocation rules have been modified by the regulations to require that the S corporation income of an ESBT be included in the S portion of an ESBT and taxed to the trust. Previously that income would have been allocated to an NRA deemed owner and not the trust under the grantor trust rules. The final regulations apply to all ESBTs after December 31, 2017, and are effective June 18, 2019.

The IRS offers the following as an example of the new regulations. A Domestic Trust (“DT”) has a valid ESBT election in effect and the DT owns S corporation stock. The S corporation owns both U.S. and foreign assets and the foreign assets produce foreign source income. The beneficiary (“B”), an NRA, is both the grantor and the only trust beneficiary and potential current beneficiary of the DT. B is also not a resident of a country with which the U.S. has an income tax treaty. Under the existing law B is treated as the owner of the DT because, per the trust documents, income and principal may be distributed only to B during B’s lifetime. Per the recently issued regulations, the S corporation income of the ESBT that otherwise would have been allocated to B per the grantor trust rules must be reallocated from B’s grantor portion to the S portion of the DT. In this example, the S portion of DT is treated as including the grantor portion of the ESBT, and thus all of the DT’s income from the S corporation is taxable to the DT. As such, all income allocated to the NRA will be taxable to the DT.

To find out more information on the treatment of trusts owning S corporation stock as it relates to non-resident alien beneficiaries, please contact Wayne Rodney or Mike Kirkman to discuss. Your Cherry Bekaert professionals look forward to working with you.