7778 / What is an electing small business trust (ESBT)?

An ESBT is a trust in which all of the beneficiaries are individuals, estates, or charitable organizations.¹ Each potential current beneficiary of an ESBT is treated as a shareholder for purposes of the shareholder limitation.² A potential current beneficiary is generally, with respect to any period, someone who is entitled to, or in the discretion of any person may receive, a distribution of principal or interest of the trust. In addition, a person treated as an owner of a trust under the grantor trust rules (see Q 797) is a potential current beneficiary.³ If for any period there is no potential current beneficiary of an ESBT, the ESBT itself is treated as an S corporation shareholder.⁴ Trusts exempt from income tax, QSSTs, charitable remainder annuity trusts, and charitable remainder unitrusts may not be ESBTs. An interest in an ESBT may not be obtained by purchase.⁵ If any portion of a beneficiary’s basis in the beneficiary’s interest is determined under the cost basis rules, the interest was acquired by purchase.⁶ An ESBT is taxed at the highest income tax rate under IRC Section 1(e) (39.6 percent for 2013017, 37 percent for 2018025).⁷ The 2017 tax reform legislation expanded the definition of a qualifying beneficiary under an electing small business trust (ESBT) to include nonresident aliens.⁸ This provision is effective beginning January 1, 2018.

---

1. IRC § 1361(e).

2. IRC § 1361(c)(2)(B)(v).

3. Treas. Reg. § 1.1361-1(m)(4).