IT 2000-01 - Grantor Trust Provisions Take Precedence
Over ESBT Provisions - January 19, 2000
Effective for individual and estate taxable years beginning
after December 31, 1999, the Income Tax Audit Division will
require certain individuals and estates to include in their
federal adjusted gross income ("FAGI") and Ohio taxable
income all relevant pass-through items of income, gain or
loss from S corporations when such items have been treated as
reportable for federal income tax purposes on a trust's
fiduciary income tax return (Form 1041) because the trust has
elected to be taxed as an Electing Small Business Trust
("ESBT") under Internal Revenue Code ("IRC") section
1361(e)(3). Specifically, if an individual or estate would be
treated as the owner of all or a portion of a trust pursuant
to IRC section 671 et seq., then such individual or estate
shall include in his, her or its FAGI or Ohio taxable income
all relevant S corporation pass-through items as if the
individual or estate were itself the actual owner of the S
corporation stock owned by the trust.1
Furthermore, because the Income Tax Audit Division will treat
such trusts as grantor trusts rather than as ESBT's, the
qualify as an electing small business trust excluded, under
Ohio Revised Code ("ORC") section 5733.40(I)(1), from the
definition of a "qualifying investor." As such, for taxable
years beginning after December 31, 1999, an S corporation
must pay the 5% pass-through entity withholding tax and
related estimated tax (ORC sections 5747.41 and 5747.43) with
respect to "adjusted qualifying amounts" (ORC section
5733.40(A)(1)(a)) which pass through to such trusts.
For taxable years beginning after December 31, 1999,
assessments for unpaid tax and all related
failure-to-timely-pay and failure-to-timely-file charges will
apply (i) to such individuals and estates who do not adjust
their FAGI and Ohio taxable income (and timely pay tax and
related estimated tax thereon) in accordance with this
information release and (ii) to S corporations which do not
timely pay the 5% withholding tax and the related estimated
tax with respect to such S corporation distributive shares.
The Internal Revenue Code does not contain any provisions
which expressly state that an ESBT which also qualifies as
and/or is described as a grantor trust is exempt from the
grantor trust provisions. Neither does the "Blue Book"
provide or address any such exemption.2 In
fact, the principal advocate of the ESBT legislation has
cautioned that the provisions of an ESBT's governing
instruments ". . . should be limited so that no power would
result in the inclusion of trust assets or revenue in the
trustee's own estate or income."3 Thus,
even the principal advocate of the ESBT legislation
implicitly recognizes that an ESBT which also qualifies as
and/or is described as a grantor trust is, in fact, subject
to the grantor trust provisions for taxation rather than
qualifying for the special rules for taxation of ESBT's under
IRC section 641(c).
The Income Tax Audit Division recognizes that various tax
practitioners have differing interpretations of how the ESBT
provisions interplay with the grantor trust provisions of the
Internal Revenue Code. Some have advocated that the ESBT
provisions should take precedence over the grantor trust
provisions, while others believe that a grantor trust can-not
make the ESBT election.4 In light of the
fact that neither the U.S. Treasury Department nor the
Internal Revenue Service has issued any guidance in this
area, and barring any change in the federal tax law or
issuance of new U.S. Treasury regulations to the contrary,
the Income Tax Audit Division's position is that a grantor
trust cannot make the ESBT election.
If you have questions regarding this information release,
please contact the Income Tax Audit Division at 614-433-7610
1Of course, individuals and estates will not
have to make these adjustments to the extent these
individuals and estates have already done so on their
federal income tax returns.
2Staff of the Joint Committee on Taxation,
Explanation of Tax Legislation Enacted in the 104th
3See the last sentence of Frederick G.
Corneel's article, "The Electing Small Business Trust:
Subchapter S's User-Friendly Estate Planning Tool"
beginning on page 215 of the April, 1997 issue of the
Taxation. The "Editor's Note" appearing in that
article states as follows:
"Mr. Corneel was the principal advocate on Capitol Hill
for ESBTs, and he worked with the staffs of both the
Joint Committee and Treasury in drafting the
. . . Moreover, until there is Treasury guidance or
further legislation, his analysis of the law stands as
uniquely important to any potential users of this new
estate planning tool."
4See item number 4 in the American Institute
of Certified Public Accountants December 21, 1999
correspondence to IRS Assistant Chief Counsel Paul F.
Kugler. That letter is reproduced in the December 29,
1999 edition of BNA, Inc.'s TaxCore. But see
Apple, "Ohio Income Tax Treatment of The Newest "S"
Corporation Shareholder: The Electing Small Business
Ohio CPA Journal, April - June, 1998 on page 29,
4th line down: "Grantor trusts cannot elect to be treated
as an ESBT."