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is approved as a generic copy of
Pharmacia & Upjohn Co.’s LINCOMIX
300, approved under NADA 34–025.
The application is approved as of
February 1, 2002, and the regulations
are amended in 21 CFR 522.1260 to
reflect the approval. The basis of
approval is discussed in the freedom of
information summary. Section 522.1260
is also being amended to reflect a
current format.
In accordance with the freedom of
information provisions of 21 CFR part
20 and 514.11(e)(2)(ii), a summary of
safety and effectiveness data and
information submitted to support
approval of this application may be seen
in the Dockets Management Branch
(HFA–305), Food and Drug
Administration, 5630 Fishers Lane, rm.
1061, Rockville, MD 20852, between 9
a.m. and 4 p.m., Monday through
Friday.
The agency has determined under 21
CFR 25.33(a)(1) that this action is of a
type that does not individually or
cumulatively have a significant effect on
the human environment. Therefore,
neither an environmental assessment
nor an environmental impact statement
is required.
This rule does not meet the definition
of ‘‘rule’’ in 5 U.S.C. 804(3)(A) because
it is a rule of ‘‘particular applicability.’’
Therefore, it is not subject to the
congressional review requirements in 5
U.S.C. 801–808.
List of Subjects in 21 CFR Part 522

PART 522—IMPLANTATION OR
INJECTABLE DOSAGE FORM NEW
ANIMAL DRUGS
1. The authority citation for 21 CFR
part 522 continues to read as follows:
Authority: 21 U.S.C. 360b.

2. Section 522.1260 is amended by
revising the section heading and
paragraphs (a), (b), (e)(1)(i), (e)(1)(iii),
(e)(2)(i), and (e)(2)(iii) to read as follows:
Lincomycin.

(a) Specifications. Each milliliter of
solution contains lincomycin
hydrochloride monohydrate equivalent
to 25, 50, 100, or 300 milligrams (mg)
of lincomycin.
(b) Sponsors. See sponsors in
§ 510.600(c) of this chapter for uses as
in paragraph (e) of this section.

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Dates of Applicability: The
regulations regarding ESBTs under
§ 1.641(c)–1(d) through (k), (l) Examples
2–5, § 1.1361–1(h)(1)(vi), (h)(3)(i)(F),
(h)(3)(ii), (j)(12), and (m), § 1.1362–
6(b)(2)(iv), § 1.1377–1(a)(2)(iii) and (c)
Example 3 apply for taxable years
beginning on and after May 14, 2002.
The regulations regarding taxation of
ESBTs under § 1.641(c)–1(a), (b), (c),
and (l) Example 1 are applicable for
taxable years of ESBTs that end on and
after December 29, 2000. The
regulations under § 1.444–4 are
applicable to taxable years beginning on
or after December 29, 2000.
FOR FURTHER INFORMATION CONTACT:
Concerning the final regulations,
Bradford Poston or James A. Quinn,
(202) 622–3060; specifically concerning
§ 1.444–4, Michael F. Schmit, (202)
622–4960 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:

Dated: April 26, 2002.
Stephen F. Sundlof,
Director, Center for Veterinary Medicine.
[FR Doc. 02–11933 Filed 5–13–02; 8:45 am]

Paperwork Reduction Act

BILLING CODE 4160–01–S

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8994]
RIN 1545–AU76

Animal drugs.
Therefore, under the Federal Food,
Drug, and Cosmetic Act and under
authority delegated to the Commissioner
of Food and Drugs and redelegated to
the Center for Veterinary Medicine, 21
CFR part 522 is amended as follows:

§ 522.1260

(1) No. 000009 for uses as in
paragraph (e) of this section.
(2) No. 046573 for use as in paragraph
(e)(2) of this section.
*
*
*
*
*≤
(e) * * *
(1) * * *
(i) Amount. 5 mg per pound (/lb) of
body weight twice daily or 10 mg/lb
body weight once daily by
intramuscular injection; 5 to 10 mg/lb
body weight one or two times daily by
slow intravenous injection.
*
*
*
*
*≤
(iii) Limitations. Federal law restricts
this drug to use by or on the order of
a licensed veterinarian.
(2) * * *
(i) Amount. 5 mg/lb body weight once
daily by intramuscular injection for 3 to
7 days.
*
*
*
*
*≤
(iii) Limitations. Do not treat within
48 hours of slaughter.

Electing Small Business Trust
AGENCY: Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations and removal of
temporary regulations.
SUMMARY: This document contains final
regulations relating to the qualification
and treatment of electing small business
trusts (ESBTs). The final regulations
interpret the rules added to the Internal
Revenue Code (Code) by section 1302 of
the Small Business Job Protection Act of
1996, section 1601 of the Taxpayer
Relief Act of 1997, and section 316 of
the Community Renewal Tax Relief Act
of 2000. In addition, the final
regulations provide that an ESBT, or a
trust described in section 401(a) of the
Code or section 501(c)(3) of the Code
and exempt from taxation under section
501(a) of the Code, is not treated as a
deferral entity for purposes of § 1.444–
2T. The final regulations affect S
corporations and certain trusts that own
S corporation stock.
DATES: Effective Date: These regulations
are effective May 14, 2002.

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The collections of information in
these final regulations have been
reviewed and, pending receipt and
evaluation of public comments,
approved by the Office of Management
and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C.
3507) and assigned control number
1545–1591.
The collections of information in
these final regulations are in § 1.1361–
1(j)(12), § 1.1361–1(m), and § 1.444–4(c).
The information required by § 1.1361–
1(j)(12) and § 1.1361–1(m) is needed to
allow trusts to elect to be ESBTs and to
allow for the conversion of a qualified
subchapter S trust (QSST) to an ESBT
and the conversion of an ESBT to a
QSST. The likely respondents are trusts.
The information required by § 1.444–
4(c) is needed to allow certain S
corporations to reinstate their previous
taxable year that was terminated under
§ 1.444–2T. The likely respondents are
businesses and other for-profit
institutions.
Comments on the collections of
information should be sent to the Office
of Management and Budget, Attn.: Desk
Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503 with copies to the Internal
Revenue Service, Attn.: IRS Reports
Clearance Officer, W:CAR:MP:FP:S,
Washington, DC 20224. Comments on
the collection of information should be
received by July 15, 2002. Comments are
specifically requested concerning:
Whether the collections of
information are necessary for the proper
performance of the functions of the
Internal Revenue Service, including

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whether the information will have
practical utility;
The accuracy of the estimated burden
associated with the collections of
information;
How the quality, utility, and clarity of
the information to be collected may be
enhanced;
How the burden of complying with
the collections of information may be
minimized, including through the
application of automated collection
techniques or other forms of information
technology; and
Estimates of capital or start-up costs
of operation, maintenance, and
purchase of service to provide
information.
The burden contained in § 1.444–4 is
reflected in the burden of Form 8716.
Estimated total annual reporting
burden: 7,500 hours.
Estimated annual burden per
respondent: 1 hour.
Estimated number of respondents:
7,500.
Estimated annual frequency of
responses: On occasion.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a valid control
number assigned by the Office of
Management and Budget.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
On December 29, 2000, proposed
regulations (REG–251701–96) were
published in the Federal Register (65
FR 82963) containing proposed
amendments to the Income Tax
Regulations (26 CFR part 1) relating to
S corporations and electing small
business trusts (ESBTs). Section 1302 of
the Small Business Job Protection Act of
1996, Public Law 104–188 (110 Stat.
1755) (August 20, 1996) (the 1996 Act),
amended sections 641 and 1361 of the
Code to permit an ESBT to be an S
corporation shareholder. Further
amendments were made to section
1361(e) by the Taxpayer Relief Act of
1997, Public Law 105–34 (111 Stat.
1601(c)(1)) (August 5, 1997), and the
Community Renewal Tax Relief Act of
2000, Public Law 106–554 (114 Stat.
2763) (December 21, 2000). Prior section
641(d) was redesignated as section
641(c) by the Internal Revenue Service
Restructuring and Reform Act of 1998,

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Public Law 105–206 (112 Stat.
6007(f)(2)) (July 22, 1998).
On December 29, 2000, proposed and
temporary regulations were also
published in the Federal Register (65
FR 82963) and (65 FR 82926) containing
amendments to the Income Tax
Regulations (26 CFR part 1) relating to
the election of a taxable year other than
the required taxable year.
A public hearing was held on the
proposed and temporary regulations on
April 25, 2001. Written comments were
received on the proposed and temporary
regulations. The proposed regulations,
with certain changes in response to the
comments, are adopted as final
regulations, and the temporary
regulations are removed.
Summary of Comments and
Explanation of Revisions
Beneficiaries and Potential Current
Beneficiaries
For a trust to qualify as an electing
small business trust (ESBT) and as a
shareholder in a subchapter S
corporation, only certain types of
persons are permitted to be beneficiaries
of the trust. Once a trust makes the
ESBT election, each potential current
beneficiary (PCB) of the trust is treated
as a shareholder of the S corporation.
Thus, the identity of the beneficiaries
affects whether a trust can be an ESBT,
while the identity and number of PCBs
affect whether the corporation can be a
S corporation. It is possible under
certain circumstances for a person to be
a PCB, as that term is defined in section
1361(e)(2) and the proposed regulations,
without being a beneficiary, as that term
is defined in the proposed regulations.
For example, a person who may receive
a distribution from an ESBT under a
currently exercisable power of
appointment is a PCB but is not treated
as a beneficiary until the power is
actually exercised.
Some commentators expressed
concerns about the possible adverse
effects of the definition of PCBs,
especially in situations involving
potential recipients of a currently
exercisable power of appointment.
Some commentators suggested that a
person should have to meet the
definition of a beneficiary before the
person could be considered a PCB.
Commentators also suggested that a
person who may receive a distribution
under a currently exercisable power of
appointment should not be treated as a
PCB until exercise of the power. Several
commentators suggested that a
temporary waiver or release of a broad
power of appointment should be

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34389

sufficient to limit the number of PCBs
during a period of time.
The final regulations do not change
the basic definition of PCBs. While there
is no statutory definition of beneficiary
in section 1361(e), there is a statutory
definition of PCB. Under section
1361(e)(2), a PCB is, ‘‘with respect to
any period, any person who at any time
during such period is entitled to, or, at
the discretion of any person, may
receive, a distribution from the
principal or income of the trust.’’ The
IRS and the Treasury Department
believe that it would be inconsistent
with this statutory definition not to treat
a person as a PCB until an actual
distribution is made to that person
pursuant to the exercise of a power of
appointment. The final regulations
provide that an attempt to temporarily
waive, release, or limit a power of
appointment would not be effective to
limit the PCBs because of uncertainty as
to the effectiveness of a temporary
waiver, release, or limitation on the
power of appointment under state law
and the potential to manipulate a
temporary waiver, release, or limitation
on a power of appointment to avoid the
S corporation shareholder limitation
rules. However, a permanent release of
a power of appointment that is effective
under local law may reduce the number
of PCBs of an ESBT.
Another commentator suggested that
the separate share provisions of section
663(c) should apply so that beneficiaries
or PCBs of the share holding the assets
other than the S corporation stock
would not be counted as beneficiaries or
PCBs of the S portion. There is no
authority to ignore beneficiaries and
PCBs of a portion of a trust holding
assets other than S corporation stock.
The statutory definitions of an ESBT
and of a PCB look to all the persons who
are beneficiaries or PCBs of the trust,
not just the S portion. In addition, the
separate share provisions of section
663(c) are not applicable because they
generally apply only for purposes of
allocating distributable net income
under sections 661 and 662.
Two commentators requested
guidance on what period of time is
considered in determining who are
PCBs in light of the statutory definition.
They suggested that period means any
moment in time. Thus, if an event
occurs during a taxable year that
changes who the PCBs are, the PCBs
before and after the event would not be
counted cumulatively for purposes of
the 75-shareholder limit. The
shareholder limitation in section
1361(b)(1)(A) means that an S
corporation may not have more than 75
shareholders at any particular time

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during the taxable year. See Rev. Rul.
78–390 (1978–2 C.B. 220). The final
regulations clarify that a person is
treated as a shareholder of the S
corporation at any moment in time
when that person is entitled to, or in the
discretion of any person may, receive a
distribution of principal or income of
the trust. The final regulations also
provide that a person who, after the
exercise of a power of appointment,
receives only a future interest in the
trust is not a PCB.
One commentator was concerned
about the statement in the proposed
regulations that if a person holds a
general lifetime power of appointment,
the corporation will exceed the 75shareholder limit and thus the
corporation’s S election will terminate.
The commentator pointed out that a
beneficiary’s power to withdraw assets
from a trust is considered a general
power of appointment but the
beneficiary is the only one who can
receive those assets. The final
regulations clarify that the potential
recipients of current distributions
pursuant to an exercise of the power are
considered, not whether the power is a
general or special power of
appointment.
The proposed regulations provide that
a person with a future beneficial interest
is not a beneficiary of an ESBT if that
interest is so remote as to be negligible.
This provision permitted trusts to
qualify as ESBTs even though there was
a remote possibility that all the named
beneficiaries would die and the trust
assets would escheat to the state, an
impermissible beneficiary of an ESBT.
The Community Renewal Tax Relief Act
of 2000 eliminated this potential
problem by changing the statutory
definition of permissible beneficiaries to
include an organization described in
section 170(c)(1) that holds a contingent
interest in the trust and is not a PCB.
The final regulations, therefore, remove
the provision regarding remote
beneficiaries and the accompanying
example.
Interests in Trust Acquired by Purchase
Two commentators requested
clarification on whether a trust is
eligible to be an ESBT if it acquires
property in a part-gift, part-sale
transaction, such as a gift of
encumbered property or a net gift, in
which the donor transfers property to a
trust provided the trust pays the
resulting gift tax. Section
1361(e)(1)(A)(ii) provides that a trust is
eligible to be an ESBT only if ‘‘no
interest in the trust was acquired by
purchase.’’ Section 1361(e)(1)(C) defines
purchase as ‘‘any acquisition if the basis

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of the property acquired is determined
under section 1012.’’ The proposed
regulations provide that if any portion
of a beneficiary’s basis in the
beneficiary’s interest is determined
under section 1012, the beneficiary’s
interest was acquired by purchase. The
final regulations clarify that the
prohibition on purchases applies to
purchases of a beneficiary’s interest in
the trust, not to purchases of property
by the trust. A net gift of a beneficial
interest in a trust, where the donee pays
the gift tax, would be treated as a
purchase of a beneficial interest under
these rules, while a net gift to the trust
itself, where the trustee of the trust pays
the gift tax, would not.
Grantor Trusts
Most commentators praised the
position in the proposed regulations
that a trust, all or a portion of which is
treated as owned by an individual
(deemed owner) under subpart E, part I,
subchapter J, chapter 1 of the Code
(grantor trust), may elect to be an ESBT.
One commentator, however, suggested
that grantor trusts should not be
permitted to make ESBT elections. The
final regulations continue to provide
that a grantor trust may elect to be an
ESBT.
The proposed regulations provide that
if a grantor trust makes an ESBT
election, the trust consists of a grantor
portion, an S portion, and a non-S
portion. The items of income,
deduction, and credit attributable to the
grantor portion are taxed to the deemed
owner of that portion. The S portion is
taxed under the special rules of section
641(c), while the non-S portion is
subject to the normal trust taxation rules
of subparts A through D of subchapter
J.
Commentators made several
suggestions regarding the taxation of a
grantor trust that elects to be an ESBT.
Some suggested that the taxation rules
of section 641(c) should override the
grantor trust rules of section 671, and
thus all tax items attributable to the
trust’s shares in the S corporation
should be taxed to the trust, not the
deemed owner. Some suggested the
grantor trust rules should not apply to
any tax items of a trust that makes an
ESBT election. According to these
commentators, this approach would
eliminate administrative complexity in
determining what portion of the trust is
treated as owned by the deemed owner.
Others suggested that the trustee should
be permitted to elect to have all items
attributable to the S corporation taxed to
the trust, not to the deemed owner.
Others suggested that none of the S
items should be taxed to the deemed

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owner but that ESBTs should be subject
to additional reporting requirements to
ensure the collection of the proper tax.
Another suggested that the deemed
owner should be taxed on the items
from an ESBT only if the deemed owner
is treated as owning the entire trust, not
just a portion of the trust. Other
commentators agreed with the taxation
regime set forth in the proposed
regulations.
The IRS and the Treasury Department
believe that the qualification and
taxation of ESBTs are two separate
issues and that the proposed regulations
take the correct position regarding the
taxation of grantor trusts that make
ESBT elections. Section 1361(e)(1)
expands the permissible shareholders of
an S corporation to include trusts that
meet the definition of an ESBT. Grantor
trusts are not excluded from the
definition of an ESBT and, therefore, are
permitted to make ESBT elections.
Making an ESBT election, however,
does not alter the long established
treatment of tax items attributable to the
portion of a trust treated as owned by
the grantor or another. Section 671
requires that items of income,
deduction, and credit attributable to the
portion of the trust treated as owned by
a grantor or another must be taken into
account by that deemed owner. Only
remaining items of the trust are subject
to the provisions of subparts A through
D of subchapter J. The special taxation
rules for ESBTs are contained in subpart
A and, therefore, only apply to any
portion of the trust that is not treated as
owned by the grantor or another under
subpart E.
As pointed out by one of the
commentators, the issue of determining
what portion, if any, of a trust is treated
as owned by the grantor or another has
existed for years in a much broader
context than in the application of the
ESBT rules. The special taxation rules of
section 641(c) would apply only to S
items, while normal trust taxation rules
clearly apply to non-S items. As a result,
taxing all the S items to the trust would
not eliminate the need to determine
what portion of the trust is a grantor
trust and the resulting administrative
difficulties with respect to the non-S tax
items of the trust.
Some commentators requested
clarification of the effect of an ESBT
election by a grantor trust. One
commentator suggested that if a whollyowned grantor trust makes an ESBT
election, only the deemed owner should
be treated as the shareholder of the S
corporation. Another commentator
made a similar suggestion where the
grantor has retained the power to amend
or revoke the trust or to make gifts from

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the trust. The IRS and the Treasury
Department believe that the definitional
and qualification requirements of
section 1361(e) apply to any trust that
makes an ESBT election irrespective of
whether it is a grantor trust. Therefore,
the final regulations continue to provide
that the deemed owner is treated as a
PCB along with others who meet the
definition of a PCB.
Charitable Contributions
The proposed regulations provide that
if an otherwise allowable deduction of
the S portion is attributable to a
charitable contribution paid by the S
corporation, the contribution will be
deemed to be paid by the S portion
pursuant to the terms of the trust’s
governing instrument and will be
deductible if the other requirements of
section 642(c)(1) are met. Several
commentators requested clarification
concerning the other requirements of
section 642(c)(1), the application of the
limitations under section 681, and the
election to treat charitable payments
made after the close of a taxable year as
made during the taxable year. One
commentator suggested that the S
portion should be entitled to a
deduction for its share of any charitable
contribution made by the S corporation
because it is a separately stated item
under section 1366 that the S portion
takes into account under section
641(c)(2)(C)(i).
Section 641(c)(2)(C) specifies the
items of income, loss, deduction, or
credit that the S portion is required to
take into account in determining its tax.
These items include items required to
be taken into account under section
1366, that is, the trust’s pro rata share
of the S corporation’s items passed
through to it as a shareholder. Both
section 641(c)(2)(C) and section 1366(a)
reference items that must be taken into
account but do not themselves provide
the authority to include in income,
deduct from income, or claim a credit
with respect to those items. That
authority comes from other Code
sections. A charitable contribution made
by an S corporation is required to be a
separately stated item under section
1366 because whether the item is
deductible depends on the identity of
the shareholder and the provisions of
the Code applicable to charitable
contributions made by that type of
shareholder. Thus, for an individual
shareholder, the contribution is
deductible only in accordance with the
provisions of section 170, while for a
trust or estate, the contribution is
deductible only in accordance with the
provisions of section 642(c).

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The final regulations continue to
provide that the S portion’s share of a
charitable contribution made by the S
corporation is deductible only if it
meets the requirements of section
642(c)(1). The final regulations clarify
how those requirements apply to such a
contribution. If a contribution is paid
from the S corporation’s gross income,
the contribution will be deemed to be
paid by the S portion pursuant to the
terms of the trust’s governing
instrument. The limitations of section
681, regarding unrelated business
income, apply to determine whether the
contribution is deductible by the S
portion. The final regulations also
clarify that the charitable contribution is
deductible by the S portion, if at all,
only in the year that it is an item
required to be taken into account by the
trust under section 1366. The trustee
may not make the election to treat a
contribution made by the S corporation
after the close of the taxable year as
made during the taxable year. This
election is available only for charitable
payments actually made by the trust,
not for the trust’s share of contributions
made by another entity.
One commentator suggested that if the
trust contributes S corporation stock to
a charitable organization, the S portion
should be entitled to a charitable
deduction with respect to the
contribution. Deductions available to
the S portion are limited by section
641(c)(2)(C) to S corporation items
required to be taken into account under
section 1366 and the S portion’s share
of state and local income taxes and
administrative expenses. Charitable
contributions by the trust are not items
included in the list of items that may be
taken into account by the S portion
under section 641(c)(2)(C).
Therefore, the final regulations do not
change the rule that no deduction is
available to either the S portion or the
non-S portion with respect to a
contribution of S corporation stock to
charity.
Interest Paid on Loans To Acquire S
Corporation Stock
The proposed regulations provide that
interest expense incurred by the trust to
purchase S corporation stock is
allocated to the S portion but is not an
administrative expense. Therefore, the
interest is not an allowable deduction of
the S portion under section
641(c)(2)(C)(iii). Several commentators
suggested that the interest should be
deductible. Some thought the interest
should be allocated to the non-S portion
and deducted under the investment
interest limitations of section 163(d).
Others thought the interest should be

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34391

allocated to the S portion but should be
considered a deductible administrative
expense. One commentator suggested
that if the shareholders are required to
buy the stock of a departing shareholder
pursuant to the terms of a stock
purchase agreement, any interest
expense incurred as a result of financing
the stock purchase with a loan should
be deductible when paid by an ESBT.
Another commentator suggested that if
interest paid on a loan to acquire S
corporation stock is not deductible, it
should be added to the basis of the
acquired stock.
Because the purchase of S corporation
stock increases the S portion, rather
than the non-S portion, of the trust,
interest expenses incurred in the
purchase should be allocated to the S
portion. These interest expenses would
be deductible by the S portion only if
they are ‘‘administrative expenses’’
under section 641(c)(2)(C)(iii). The IRS
and the Treasury Department believe
that, for purposes of section
641(c)(2)(C)(iii), ‘‘administrative
expenses’’ include the traditional
expenses necessary for the management
and preservation of trust assets, but do
not include expenses incurred to
acquire additional assets. The final
regulations, therefore, continue to
provide that, in all cases, interest
incurred to purchase S corporation
stock is a nondeductible expense
allocable to the S portion. Because there
is no authority to permit nondeductible
interest expenses to increase the basis of
assets, the final regulations do not adopt
this suggestion.
Tax Credit Carryovers
Section 641(c)(4) and the proposed
regulations provide that if a trust is no
longer an ESBT, any loss carryover or
excess deductions of the S portion that
are referred to in section 642(h) are
taken into account by the entire trust or
by the beneficiaries if the entire trust
terminates. One commentator suggested
that any tax credit carryovers of the S
portion should receive similar
treatment. Section 641(c)(4) permits the
entire trust to take into account only
those items specified in section 642(h),
which does not include tax credit
carryovers. The S portion’s tax credit
carryovers and any other items not
listed in section 642(h) are forfeited
once the trust is no longer an ESBT, just
as they are upon the termination of a
trust or estate. The final regulations,
therefore, do not adopt the
commentator’s suggestion.
Distributions From the ESBT
One commentator suggested that the
tax treatment of distributions to

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beneficiaries in the proposed
regulations is inconsistent with section
641(c)(1)(A), which provides that the
portion of an ESBT consisting of the S
corporation stock is treated as a separate
trust. The proposed regulations provide
that distributions to beneficiaries from
the S portion or the non-S portion,
including distributions of the S
corporation stock, are, to the extent of
the distributable net income of the nonS portion, deductible under section 651
or 661 in determining the taxable
income of the non-S portion, and are
includible in the gross income of the
beneficiaries under section 652 or 662.
The commentator recommended that,
because the S portion and the non-S
portion are treated as separate trusts, the
source of the distribution should
determine its tax treatment.
The final regulations do not adopt the
commentator’s suggestion because
section 641(c)(3) provides that section
641(c) does not affect the taxation of any
distribution from the trust except for the
exclusion of the S portion items from
the distributable net income of the
entire trust. Thus, the rules otherwise
applicable to trust distributions apply to
ESBTs.

that may be grantor trusts under section
674. The IRS and the Treasury
Department continue to believe that a
conditional ESBT election that only
becomes effective in the event the trust
is not a wholly-owned grantor trust
should not be available. A conditional
ESBT election should not be allowed
because the ESBT election must have a
fixed effective date. If, in the absence of
a conditional ESBT election, the trust is
an ineligible shareholder, relief under
section 1362(f) may be available for an
S corporation. In addition, a trust that
qualifies as an ESBT may make an ESBT
election notwithstanding that the trust
is a wholly-owned grantor trust.

ESBT Election
The proposed regulations provide that
the ESBT election is filed with the
service center where the trust files its
income tax returns. The election to be
a qualified subchapter S trust (QSST) is
filed with the service center where the
S corporation files its income tax
returns. The preamble to the proposed
regulations requested comments on
whether the rules for filing the QSST
election should be changed so the
election is filed with the service center
where the trust files its returns. One
commentator suggested there should be
consistent filing locations for QSST
elections, ESBT elections, and
conversions from QSST to ESBT or
ESBT to QSST. The commentator,
therefore, suggested that all these
documents be filed with the service
center(s) where the trust and the S
corporation file their returns.
The final regulations provide that the
ESBT election and the election to
convert from an ESBT to a QSST or from
a QSST to an ESBT are all filed with the
service center where the S corporation
files its income tax returns. Thus, the
rule in the final regulations will
establish a consistent filing location for
QSST and ESBT elections and
conversions.
One commentator suggested that
grantor trusts should be permitted to
make protective ESBT elections in light
of the uncertain status of some trusts

Effect Under Section 1377 of Change in
Status of a Trust
A commentator suggested that a
trust’s conversion to an ESBT should
result in a complete termination of the
trust’s interest in the S corporation for
purposes of section 1377(a)(2) because
the incidence of taxation with respect to
S corporation items will change as a
result of the ESBT election. The
proposed regulations provide that the
election would result in a termination
only if, prior to the election, the trust
was described in section
1361(c)(2)(A)(ii) or (iii). The
commentator also recommended that
the regulations address the conversion
from an ESBT to another type of trust
and the availability of an election under
§ 1.1368–1(g) to treat the S corporation’s
taxable year as two separate years in the
case of a qualifying disposition.
The final regulations do not adopt the
suggestion that all conversions of a trust
to an ESBT should be treated as a
complete termination of the trust’s
interest in the S corporation for
purposes of section 1377(a)(2). The final
regulations expand on the rule in the
proposed regulations to cover all types
of conversions. Under this rule,
conversion of a trust to an ESBT or a
QSST does not result in the prior trust
terminating its entire interest in the S
corporation, unless the prior trust was
described in section 1361(c)(2)(A)(ii) or
(iii). When a trust described in section

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Expedited Section 1362(f) Relief
In several contexts, commentators
requested some form of expedited relief
if an S corporation’s election is
inadvertently ineffective or is
inadvertently terminated. In all these
situations, the S corporation may seek
relief under section 1362(f). The facts
and circumstances of a particular
situation are considered in determining
whether relief is available, and the
procedures for obtaining this relief are
well established.

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1361(c)(2)(A)(ii) or (iii) converts to an
ESBT or a QSST, the shareholders of the
S corporation under section
1361(c)(2)(B) change from the estate of
the deemed owner or testator to the
PCBs of the ESBT, or the current income
beneficiary of the QSST. When a trust
changes from a wholly-owned grantor
trust or QSST to an ESBT or from an
ESBT to a QSST, the individuals who
are shareholders of the S corporation
under section 1361(c)(2)(B) remain the
same. The election to terminate the
taxable year provided in section
1377(a)(2) applies to the termination of
a shareholder’s interest in the S
corporation.
Accordingly, it is appropriate to treat
the conversion of a trust described in
section 1361(c)(2)(A)(ii) or (iii) to an
ESBT or QSST as a termination of the
prior trust’s interest in the S
corporation, but not to treat other
conversions to an ESBT or QSST as
terminations. The election under
§ 1.1368–1(g) is also not available
because the conversion of the trust is
not a qualifying disposition.
Section 444 Elections
One commentator suggested that the
final regulations permit an S
corporation to retroactively reinstate a
section 444 election that it had treated
as terminated by operation of § 1.444–
2T(a) (prior to the issuance of the
temporary regulations) as a result of an
ESBT or certain tax-exempt trusts
becoming a shareholder of the
corporation under the auspices of the
1996 Act. The commentator believes
that failure to provide such relief would
result in inequitable treatment of such S
corporations because, under the rules of
section 444, once their elections are
terminated, they are precluded from
again making a section 444 election.
The IRS and the Treasury Department
believe that it is appropriate to allow S
corporations under these circumstances
to request that the IRS disregard the
termination and permit the S
corporation to continue to use the same
fiscal year that it used previously under
section 444. However, for reasons of
administrative convenience, and in
order to reduce the burden on taxpayers
of having to file amended returns and
make retroactive payments under
section 7519, the prior termination will
be disregarded only at the S
corporation’s request, and on a
prospective basis.
The final regulations provide a
procedure for such requests. To
illustrate the procedure, assume that,
prior to 1997, an S corporation had
made a section 444 election to use a
taxable year ending on September 30th.

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Federal Register / Vol. 67, No. 93 / Tuesday, May 14, 2002 / Rules and Regulations
On January 1, 1997, an ESBT acquired
a shareholder interest in the S
corporation. The S corporation treated
its 444 election as terminated under
§ 1.444–2T(a) as a result of the ESBT’s
shareholder interest. The S corporation
changed to its required taxable year for
the short period beginning October 1,
1996, and ending December 31, 1996,
and filed Form 1120S, ‘‘U.S. Income Tax
Return for an S Corporation,’’ on the
basis of a calendar year for all
subsequent taxable years.
Under the final regulations, the S
corporation may request that the IRS
disregard the prior termination by filing
Form 8716, ‘‘Election to Have a Tax
Year Other Than a Required Tax Year,’’
with the appropriate Service Center by
October 15, 2002, and by designating on
the form ‘‘CONTINUATION OF
SECTION 444 ELECTION UNDER
§ 1.444–4.’’ The Form 8716 must
indicate that under the S corporation’s
prior section 444 election, it used a
taxable year ending September 30th.
The request will be effective for the
taxable year beginning January 1, 2002.
No amended returns, no retroactive
payments under section 7519, and no
returns under § 1.7519–2T(a) for
previous years in which the S
corporation used its required year are
required as a result of the request.
Moreover, the S corporation need not
make a required payment under section
7519 for its taxable year ending
September 30, 2002; its first required
payment for the taxable year beginning
October 1, 2002, is due on May 15,
2003. The S corporation will be required
to file a return under § 1.7519–2T for
each taxable year beginning on or after
January 1, 2002.
Effective Dates
The portion of the regulations
involving the taxation of the grantor, S,
and non-S portions of an ESBT was
proposed to be applicable for taxable
years of ESBTs that end on or after
December 29, 2000, the date that the
proposed regulations were published in
the Federal Register. The remainder of
the regulations involving ESBTs was
proposed to be applicable on or after the
date that final regulations are published
in the Federal Register. Several
commentators expressed concerns about
the proposed applicability with regard
to the taxation of the grantor portion of
an ESBT. One commentator suggested
that the proposed effective date
discriminated against trusts with a situs
in Guam. Others suggested that the rules
regarding taxation of the grantor portion
should not be applicable before the date
the final regulations are published. One
commentator suggested that these rules

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should only apply either to trusts
created after the final regulations are
published or after a substantial
transition period.
The IRS and the Treasury Department
believe that the applicable date for the
rules concerning the taxation of an
ESBT with a grantor portion is
reasonable and appropriate. These rules
do not discriminate against trusts with
a particular situs because they apply to
all trusts wherever situated. In the case
of a grantor trust that made an ESBT
election, the tax treatment of the grantor
portion set forth in the proposed
regulations may be different from the
tax treatment that the trust and the
grantor had thought was available. The
proposed regulations, however, were
published before the end of the 2000
taxable year and before income from
that taxable year was required to be
included on any person’s income tax
return. Thus, prior to the filing of
income tax returns for 2000, it was
known that the income from the grantor
portion of the trust was to be taken into
account by the deemed owner, not by
the trust. In some situations, the trust,
rather than the deemed owner, may
have made estimated tax payments.
Recognizing that the payment of
estimated tax by the trust might subject
the deemed owner to a penalty for
underpayment of estimated taxes, the
IRS and the Treasury Department
provided relief by issuing Notice 2001–
25 (2001–13 I.R.B. 941). That Notice
provides procedures for a trust to elect
to have its estimated tax payments
credited to the account of the deemed
owner and provides that, for purposes of
calculating any underpayment of
estimated tax, income attributable to the
S corporation was to be taken into
account on the last day of the deemed
owner’s 2000 taxable year.
Some commentators were concerned
that existing ESBTs with currently
exercisable, broad powers of
appointments have resulted in S
corporations exceeding the shareholder
limit and have caused the termination of
the S corporations’ elections. The
regulations regarding the definition of
PCBs are applicable only for taxable
years of ESBTs that begin on or after
May 14, 2002. Therefore, persons who
may receive a distribution from an ESBT
pursuant to a currently exercisable
power of appointment will not be
considered PCBs of the ESBT until the
first day of the ESBT’s first taxable year
that begins on or after May 14, 2002,
and the S corporation’s election will not
terminate before that date. In addition,
under section 1361(e)(2) if the trust
disposes of all its stock in the S
corporation within 60 days after that

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34393

date, the persons, who would first meet
the definition of PCBs on that date, will
not be PCBs and the S corporation’s
status will not be affected.
One commentator was concerned by
the applicability date of the regulations
involving the deductibility of state and
local income taxes and administrative
expenses. Section 641(c)(2)(C)(iii)
provides that the S portion may take
into account its allocable share of state
and local income taxes and
administrative expenses, but only to the
extent provided in the regulations. The
commentator noted that before final
regulations are issued there is no
authority for an ESBT to deduct any of
these items. Therefore, the commentator
requested that trusts be allowed to rely
on the regulatory provisions regarding
these items for taxable years beginning
after December 31, 1996. The effective
date provisions have been modified
based on this suggestion.
Additional Provisions
The final regulations clarify that the
basis of S corporation stock in the S
portion must be adjusted in accordance
with section 1367 and the regulations
thereunder. If the ESBT owns stock in
more than one S corporation, the
adjustments to the basis in the S
corporation stock of each S corporation
must be determined separately.
Effect on Other Documents
The following documents are
superseded for taxable years of ESBTs
beginning on and after May 14, 2002.
Notice 97–12 (1997–1 C.B. 385)
Notice 97–49 (1997–2 C.B. 304)
Rev. Proc. 98–23 (1998–1 C.B. 662)
Special Analysis
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in
Executive Order 12866. Therefore, a
regulatory assessment is not required. It
has also been determined that section
553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply
to these regulations. It is hereby
certified that the collections of
information in the regulations will not
have a significant economic impact on
a substantial number of small entities.
This certification is based upon the fact
that (1) the estimated average burden
per trust in complying with the
collections of information in § 1.1361–
1(m) is 1 hour, and (2) the requirement
for S corporations to comply with
§ 1.444–4(c) will affect very few
taxpayers and the associated burden is
minimal. Therefore, a Regulatory
Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C.

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chapter 6) is not required. Pursuant to
section 7805(f) of the Code, the notice
of proposed rulemaking preceding these
regulations was submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment
on the regulations’ impact on small
business.
Drafting Information
The principal authors of these
regulations are Bradford Poston and
James A. Quinn of the Office of
Associate Chief Counsel (Passthroughs
and Special Industries), IRS. However,
other personnel from the IRS and the
Treasury Department participated in
their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping
requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART I—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an entry
in numerical order to read in part as
follows:
Authority: 26 U.S.C. 7805. * * *

Section 1.444–4 is also issued under
26 U.S.C. 444(g). * * *
Par. 2. Section 1.444–4 is added to
read as follows:
§ 1.444–4

Tiered structure.

(a) Electing small business trusts. For
purposes of § 1.444–2T, solely with
respect to an S corporation shareholder,
the term deferral entity does not include
a trust that is treated as an electing
small business trust under section
1361(e). An S corporation with an
electing small business trust as a
shareholder may make an election
under section 444. This paragraph is
applicable to taxable years beginning on
and after December 29, 2000; however,
taxpayers may voluntarily apply it to
taxable years of S corporations
beginning after December 31, 1996.
(b) Certain tax-exempt trusts. For
purposes of § 1.444–2T, solely with
respect to an S corporation shareholder,
the term deferral entity does not include
a trust that is described in section 401(a)
or 501(c)(3), and is exempt from
taxation under section 501(a). An S

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corporation with a trust as a shareholder
that is described in section 401(a) or
section 501(c)(3), and is exempt from
taxation under section 501(a) may make
an election under section 444. This
paragraph is applicable to taxable years
beginning on and after December 29,
2000; however taxpayers may
voluntarily apply it to taxable years of
S corporations beginning after December
31, 1997.
(c) Certain terminations disregarded—
(1) In general. An S corporation that is
described in this paragraph (c)(1) may
request that a termination of its election
under section 444 be disregarded, and
that the S corporation be permitted to
resume use of the year it previously
elected under section 444, by following
the procedures of paragraph (c)(2) of
this section. An S corporation is
described in this paragraph if the S
corporation is otherwise qualified to
make a section 444 election, and its
previous election was terminated under
§ 1.444–2T(a) solely because—
(i) In the case of a taxable year
beginning after December 31, 1996, a
trust that is treated as an electing small
business trust became a shareholder of
such S corporation; or
(ii) In the case of a taxable year
beginning after December 31, 1997, a
trust that is described in section 401(a)
or 501(c)(3), and is exempt from
taxation under section 501(a) became a
shareholder of such S corporation.
(2) Procedure—(i) In general. An S
corporation described in paragraph
(c)(1) of this section that wishes to make
the request described in paragraph (c)(1)
of this section must do so by filing Form
8716, ‘‘Election To Have a Tax Year
Other Than a Required Tax Year,’’ and
typing or printing legibly at the top of
such form—‘‘CONTINUATION OF
SECTION 444 ELECTION UNDER
§ 1.444–4.’’ In order to assist the Internal
Revenue Service in updating the S
corporation’s account, on Line 5 the Box
‘‘Changing to’’ should be checked.
Additionally, the election month
indicated must be the last month of the
S corporation’s previously elected
section 444 election year, and the
effective year indicated must end in
2002.
(ii) Time and place for filing Form
8716. Such form must be filed on or
before October 15, 2002, with the
service center where the S corporation’s
returns of tax (Forms 1120S) are filed.
In addition, a copy of the Form 8716
should be attached to the S
corporation’s short period Federal
income tax return for the first election
year beginning on or after January 1,
2002.

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(3) Effect of request—(i) Taxable years
beginning on or after January 1, 2002.
An S corporation described in
paragraph (c)(1) of this section that
requests, in accordance with this
paragraph, that a termination of its
election under section 444 be
disregarded will be permitted to resume
use of the year it previously elected
under section 444, commencing with its
first taxable year beginning on or after
January 1, 2002. Such S corporation will
be required to file a return under
§ 1.7519–2T for each taxable year
beginning on or after January 1, 2002.
No payment under section 7519 will be
due with respect to the first taxable year
beginning on or after January 1, 2002.
However, a required payment will be
due on or before May 15, 2003, with
respect to such S corporation’s second
continued section 444 election year that
begins in calendar year 2002.
(ii) Taxable years beginning prior to
January 1, 2002. An S corporation
described in paragraph (c)(1) of this
section that requests, in accordance
with this paragraph, that a termination
of its election under section 444 be
disregarded will not be required to
amend any prior Federal income tax
returns, make any required payments
under section 7519, or file any returns
under § 1.7519–2T, with respect to
taxable years beginning on or after the
date the termination of its section 444
election was effective and prior to
January 1, 2002.
(iii) Section 7519: required payments
and returns. The Internal Revenue
Service waives any requirement for an
S corporation described in paragraph
(c)(1) of this section to file the federal
tax returns and make any required
payments under section 7519 for years
prior to the taxable year of continuation
as described in paragraph (c)(3)(i) of this
section, if for such years the S
corporation filed its federal income tax
returns on the basis of its required
taxable year.
§ 1.444–4T

[Removed]

Par. 3. Section 1.444–4T is removed.
Par. 4. Sections 1.641(c)–0 and
1.641(c)–1 are added to read as follows:
§ 1.641(c)–0

Table of contents.

This section lists the major captions
contained in § 1.641(c)–1.
§ 1.641(c)–1 Electing small business trust.
(a) In general.
(b) Definitions.
(1) Grantor portion.
(2) S portion.
(3) Non-S portion.
(c) Taxation of grantor portion.
(d) Taxation of S portion.
(1) In general.

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(2) Section 1366 amounts.
(3) Gains and losses on disposition of S
stock.
(4) State and local income taxes and
administrative expenses.
(e) Tax rates and exemption of S portion.
(1) Income tax rate.
(2) Alternative minimum tax exemption.
(f) Adjustments to basis of stock in the S
portion under section 1367.
(g) Taxation of non-S portion.
(1) In general.
(2) Dividend income under section
1368(c)(2).
(3) Interest on installment obligations.
(4) Charitable deduction.
(h) Allocation of state and local income
taxes and administration expenses.
(i) Treatment of distributions from the
trust.
(j) Termination or revocation of ESBT
election.
(k) Effective date.
(l) Examples.
§ 1.641(c)–1

Electing small business trust.

(a) In general. An electing small
business trust (ESBT) within the
meaning of section 1361(e) is treated as
two separate trusts for purposes of
chapter 1 of the Internal Revenue Code.
The portion of an ESBT that consists of
stock in one or more S corporations is
treated as one trust. The portion of an
ESBT that consists of all the other assets
in the trust is treated as a separate trust.
The grantor or another person may be
treated as the owner of all or a portion
of either or both such trusts under
subpart E, part I, subchapter J, chapter
1 of the Internal Revenue Code. The
ESBT is treated as a single trust for
administrative purposes, such as having
one taxpayer identification number and
filing one tax return. See § 1.1361–1(m).
(b) Definitions—(1) Grantor portion.
The grantor portion of an ESBT is the
portion of the trust that is treated as
owned by the grantor or another person
under subpart E.
(2) S portion. The S portion of an
ESBT is the portion of the trust that
consists of S corporation stock and that
is not treated as owned by the grantor
or another person under subpart E.
(3) Non-S portion. The non-S portion
of an ESBT is the portion of the trust
that consists of all assets other than S
corporation stock and that is not treated
as owned by the grantor or another
person under subpart E.
(c) Taxation of grantor portion. The
grantor or another person who is treated
as the owner of a portion of the ESBT
includes in computing taxable income
items of income, deductions, and credits
against tax attributable to that portion of
the ESBT under section 671.
(d) Taxation of S portion—(1) In
general. The taxable income of the S
portion is determined by taking into

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account only the items of income, loss,
deduction, or credit specified in
paragraphs (d)(2), (3), and (4) of this
section, to the extent not attributable to
the grantor portion.
(2) Section 1366 amounts—(i) In
general. The S portion takes into
account the items of income, loss,
deduction, or credit that are taken into
account by an S corporation shareholder
pursuant to section 1366 and the
regulations thereunder. Rules otherwise
applicable to trusts apply in
determining the extent to which any
loss, deduction, or credit may be taken
into account in determining the taxable
income of the S portion. See § 1.1361–
1(m)(3)(iv) for allocation of those items
in the taxable year of the S corporation
in which the trust is an ESBT for part
of the year and an eligible shareholder
under section 1361(a)(2)(A)(i) through
(iv) for the rest of the year.
(ii) Special rule for charitable
contributions. If a deduction described
in paragraph (d)(2)(i) of this section is
attributable to an amount of the S
corporation’s gross income that is paid
by the S corporation for a charitable
purpose specified in section 170(c)
(without regard to section 170(c)(2)(A)),
the contribution will be deemed to be
paid by the S portion pursuant to the
terms of the trust’s governing
instrument within the meaning of
section 642(c)(1). The limitations of
section 681, regarding unrelated
business income, apply in determining
whether the contribution is deductible
in computing the taxable income of the
S portion.
(iii) Multiple S corporations. If an
ESBT owns stock in more than one S
corporation, items of income, loss,
deduction, or credit from all the S
corporations are aggregated for purposes
of determining the S portion’s taxable
income.
(3) Gains and losses on disposition of
S stock—(i) In general. The S portion
takes into account any gain or loss from
the disposition of S corporation stock.
No deduction is allowed under section
1211(b)(1) and (2) for capital losses that
exceed capital gains.
(ii) Installment method. If income
from the sale or disposition of stock in
an S corporation is reported by the trust
on the installment method, the income
recognized under this method is taken
into account by the S portion. See
paragraph (g)(3) of this section for the
treatment of interest on the installment
obligation. See § 1.1361–1(m)(5)(ii)
regarding treatment of a trust as an
ESBT upon the sale of all S corporation
stock using the installment method.
(iii) Distributions in excess of basis.
Gain recognized under section

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34395

1368(b)(2) from distributions in excess
of the ESBT’s basis in its S corporation
stock is taken into account by the S
portion.
(4) State and local income taxes and
administrative expenses—(i) In general.
State and local income taxes and
administrative expenses directly related
to the S portion and those allocated to
that portion in accordance with
paragraph (h) are taken into account by
the S portion.
(ii) Special rule for certain interest.
Interest paid by the trust on money
borrowed by the trust to purchase stock
in an S corporation is allocated to the
S portion but is not a deductible
administrative expense for purposes of
determining the taxable income of the S
portion.
(e) Tax rates and exemption of S
portion—(1) Income tax rate. Except for
capital gains, the highest marginal trust
rate provided in section 1(e) is applied
to the taxable income of the S portion.
See section 1(h) for the rates that apply
to the S portion’s net capital gain.
(2) Alternative minimum tax
exemption. The exemption amount of
the S portion under section 55(d) is
zero.
(f) Adjustments to basis of stock in the
S portion under section 1367. The basis
of S corporation stock in the S portion
must be adjusted in accordance with
section 1367 and the regulations
thereunder. If the ESBT owns stock in
more than one S corporation, the
adjustments to the basis in the S
corporation stock of each S corporation
must be determined separately with
respect to each S corporation.
Accordingly, items of income, loss,
deduction, or credit of an S corporation
that are taken into account by the ESBT
under section 1366 can only result in an
adjustment to the basis of the stock of
that S corporation and cannot affect the
basis in the stock of the other S
corporations held by the ESBT.
(g) Taxation of non-S portion—(1) In
general. The taxable income of the nonS portion is determined by taking into
account all items of income, deduction,
and credit to the extent not taken into
account by either the grantor portion or
the S portion. The items attributable to
the non-S portion are taxed under
subparts A through D of part I,
subchapter J, chapter 1 of the Internal
Revenue Code. The non-S portion may
consist of more than one share pursuant
to section 663(c).
(2) Dividend income under section
1368(c)(2). Any dividend income within
the meaning of section 1368(c)(2) is
includible in the gross income of the
non-S portion.

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(3) Interest on installment obligations.
If income from the sale or disposition of
stock in an S corporation is reported by
the trust on the installment method, the
interest on the installment obligation is
includible in the gross income of the
non-S portion. See paragraph (d)(3)(ii)
of this section for the treatment of
income from such a sale or disposition.
(4) Charitable deduction. For
purposes of applying section 642(c)(1)
to payments made by the trust for a
charitable purpose, the amount of gross
income of the trust is limited to the
gross income of the non-S portion. See
paragraph (d)(2)(ii) of this section for
special rules concerning charitable
contributions paid by the S corporation
that are deemed to be paid by the S
portion.
(h) Allocation of state and local
income taxes and administration
expenses. Whenever state and local
income taxes or administration
expenses relate to more than one
portion of an ESBT, they must be
allocated between or among the portions
to which they relate. These items may
be allocated in any manner that is
reasonable in light of all the
circumstances, including the terms of
the governing instrument, applicable
local law, and the practice of the trustee
with respect to the trust if it is
reasonable and consistent. The taxes
and expenses apportioned to each
portion of the ESBT are taken into
account by that portion.
(i) Treatment of distributions from the
trust. Distributions to beneficiaries from
the S portion or the non-S portion,
including distributions of the S
corporation stock, are deductible under
section 651 or 661 in determining the
taxable income of the non-S portion,
and are includible in the gross income
of the beneficiaries under section 652 or
662. However, the amount of the
deduction or inclusion cannot exceed
the amount of the distributable net
income of the non-S portion. Items of
income, loss, deduction, or credit taken
into account by the grantor portion or
the S portion are excluded for purposes
of determining the distributable net
income of the non-S portion of the trust.
(j) Termination or revocation of ESBT
election. If the ESBT election of the trust
terminates pursuant to § 1.1361–1(m)(5)
or the ESBT election is revoked
pursuant to § 1.1361–1(m)(6), the rules
contained in this section are thereafter
not applicable to the trust. If, upon
termination or revocation, the S portion
has a net operating loss under section
172; a capital loss carryover under
section 1212; or deductions in excess of
gross income; then any such loss,

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carryover, or excess deductions shall be
allowed as a deduction, in accordance
with the regulations under section
642(h), to the trust, or to the
beneficiaries succeeding to the property
of the trust if the entire trust terminates.
(k) Effective date. This section
generally is applicable for taxable years
of ESBTs beginning on and after May
14, 2002. However, paragraphs (a), (b),
(c), and (l) Example 1 of this section are
applicable for taxable years of ESBTs
that end on and after December 29,
2000. ESBTs may apply paragraphs
(d)(4) and (h) of this section for taxable
years of ESBTs beginning after
December 31, 1996.
(l) Examples. The following examples
illustrate the rules of this section:
Example 1. Comprehensive example. (i)
Trust has a valid ESBT election in effect.
Under section 678, B is treated as the owner
of a portion of Trust consisting of a 10%
undivided fractional interest in Trust. No
other person is treated as the owner of any
other portion of Trust under subpart E. Trust
owns stock in X, an S corporation, and in Y,
a C corporation. During 2000, Trust receives
a distribution from X of $5,100, of which
$5,000 is applied against Trust’s adjusted
basis in the X stock in accordance with
section 1368(c)(1) and $100 is a dividend
under section 1368(c)(2). Trust makes no
distributions to its beneficiaries during the
year.

(ii) For 2000, Trust has the following
items of income and deduction:
Ordinary income attributable to X
under section 1366 ......................
Dividend income from Y ................
Dividend from X representing C
corporation earnings and profits
Total trust income ...........................
Charitable contributions attributable to X under section 1366 ...
Trustee fees ......................................
State and local income taxes ..........

$5,000
$900
$100
$6,000
$300
$200
$100

(iii) Trust’s items of income and
deduction are divided into a grantor
portion, an S portion, and a non-S
portion for purposes of determining the
taxation of those items. Income is
allocated to each portion as follows:
B must take into account the items of
income attributable to the grantor
portion, that is, 10% of each item, as
follows:
Ordinary income from X .................
Dividend income from Y ................
Dividend income from X ................

$500
$90
$10

Total grantor portion income ..

$600

The total income of the S portion is
$4,500, determined as follows:
Ordinary income from X .................
Less: Grantor portion .......................

$5,000
($500)

Total S portion income ............

$4,500

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The total income of the non-S portion
is $900 determined as follows:
Dividend
grantor
Dividend
grantor

income from Y (less
portion) ............................
income from X (less
portion) ............................

Total non-S portion income ....

$810
$90
$900

(iv) The administrative expenses and
the state and local income taxes relate
to all three portions and under state law
would be allocated ratably to the $6,000
of trust income. Thus, these items
would be allocated 10% (600/6000) to
the grantor portion, 75% (4500/6000) to
the S portion and 15% (900/6000) to the
non-S portion.
(v) B must take into account the
following deductions attributable to the
grantor portion of the trust:
Charitable contributions from X .....
Trustee fees ......................................
State and local income taxes ..........

$30
$20
$10

(vi) The taxable income of the S
portion is $4,005, determined as
follows:
Ordinary income from X .................
Less: Charitable contributions from
X (less grantor portion) ................
75% of trustee fees ..........................
75% of state and local income
taxes ..............................................
Taxable income of S portion ..........

$4,500
($270)
($150)
($75)
$4,005

(vii) The taxable income of the nonS portion is $755, determined as
follows:
Dividend income from Y ................
Dividend income from X ................
Total non-S portion income ............
Less: 15% of trustee fees .................
15% state and local income taxes ..
Personal exemption .........................
Taxable income of non-S portion ...

$810
$90
$900
($30)
($15)
($100)
$755

Example 2. Sale of S stock. Trust has a
valid ESBT election in effect and owns stock
in X, an S corporation. No person is treated
as the owner of any portion of Trust under
subpart E. In 2003, Trust sells all of its stock
in X to a person who is unrelated to Trust
and its beneficiaries and realizes a capital
gain of $5,000. This gain is taken into
account by the S portion and is taxed using
the appropriate capital gain rate found in
section 1(h).
Example 3. (i) Sale of S stock for an
installment note. Assume the same facts as in
Example 2, except that Trust sells its stock
in X for a $400,000 installment note payable
with stated interest over ten years. After the
sale, Trust does not own any S corporation
stock.
(ii) Loss on installment sale. Assume
Trust’s basis in its X stock was $500,000.
Therefore, Trust sustains a capital loss of

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$100,000 on the sale. Upon the sale, the S
portion terminates and the excess loss, after
being netted against the other items taken
into account by the S portion, is made
available to the entire trust as provided in
section 641(c)(4).
(iii) Gain on installment sale. Assume
Trust’s basis in its X stock was $300,000 and
that the $100,000 gain will be recognized
under the installment method of section 453.
Interest income will be recognized annually
as part of the installment payments. The
portion of the $100,000 gain recognized
annually is taken into account by the S
portion. However, the annual interest income
is includible in the gross income of the nonS portion.
Example 4. Charitable lead annuity trust.
Trust is a charitable lead annuity trust which
is not treated as owned by the grantor or
another person under subpart E. Trust
acquires stock in X, an S corporation, and
elects to be an ESBT. During the taxable year,
pursuant to its terms, Trust pays $10,000 to
a charitable organization described in section
170(c)(2). The non-S portion of Trust receives
an income tax deduction for the charitable
contribution under section 642(c) only to the
extent the amount is paid out of the gross
income of the non-S portion. To the extent
the amount is paid from the S portion by
distributing S corporation stock, no
charitable deduction is available to the S
portion.
Example 5. ESBT distributions. (i) As of
January 1, 2002, Trust owns stock in X, a C
corporation. No portion of Trust is treated as
owned by the grantor or another person
under subpart E. X elects to be an S
corporation effective January 1, 2003, and
Trust elects to be an ESBT effective January
1, 2003. On February 1, 2003, X makes an
$8,000 distribution to Trust, of which $3,000
is treated as a dividend from accumulated
earnings and profits under section 1368(c)(2)
and the remainder is applied against Trust’s
basis in the X stock under section 1368(b).
The trustee of Trust makes a distribution of
$4,000 to Beneficiary during 2003. For 2003,
Trust’s share of X’s section 1366 items is
$5,000 of ordinary income. For the year,
Trust has no other income and no expenses
or state or local taxes.
(ii) For 2003, Trust has $5,000 of taxable
income in the S portion. This income is taxed
to Trust at the maximum rate provided in
section 1(e). Trust also has $3,000 of
distributable net income (DNI) in the non-S
portion. The non-S portion of Trust receives
a distribution deduction under section 661(a)
of $3,000, which represents the amount
distributed to Beneficiary during the year
($4,000), not to exceed the amount of DNI
($3,000). Beneficiary must include this
amount in gross income under section 662(a).
As a result, the non-S portion has no taxable
income.

Par. 5. Section 1.1361–0 is amended
by adding entries for § 1.1361–1(j)(12)
and (m) to read as follows:
§ 1.1361–0

Table of contents.

*

*

*

*

*

§ 1.1361–1 S corporation defined.

*

*

*

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*

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(j) * * *
(12) Converting a QSST to an ESBT.

*

*

*

*

*

(m) Electing small business trust (ESBT).
(1) Definition.
(2) ESBT election.
(3) Effect of ESBT election.
(4) Potential current beneficiaries.
(5) ESBT terminations.
(6) Revocation of ESBT election.
(7) Converting an ESBT to a QSST.
(8) Examples.
(9) Effective date.

*

*
*
*
*
Par. 6. Section 1.1361–1 is amended
by:
1. Adding paragraphs (h)(1)(vi) and
(h)(3)(i)(F).
2. Adding a sentence to the beginning
of paragraph (h)(3)(ii) introductory text.
3. Adding paragraph (j)(12).
4. Adding a sentence to the end of
paragraph (k)(2)(i).
5. Adding paragraph (m).
The additions read as follows:

§ 1.1361–1

S corporation defined.

*

*
*
*
*
(h) * * *
(1) * * *
(vi) Electing small business trusts. An
electing small business trust (ESBT)
under section 1361(e). See paragraph
(m) of this section for rules concerning
ESBTs including the manner of making
the election to be an ESBT under section
1361(e)(3).
*
*
*
*
*
(3) * * *
(i) * * *
(F) If S corporation stock is held by an
ESBT, each potential current beneficiary
is treated as a shareholder. However, if
for any period there is no potential
current beneficiary of the ESBT, the
ESBT is treated as the shareholder
during such period. See paragraph
(m)(4) of this section for the definition
of potential current beneficiary.
*
*
*
*
*
(ii) * * * See § 1.641(c)–1 for the
rules for the taxation of an ESBT. * * *
*
*
*
*
*
(j) * * *
(12) Converting a QSST to an ESBT.
For a trust that seeks to convert from a
QSST to an ESBT, the consent of the
Commissioner is hereby granted to
revoke the QSST election as of the
effective date of the ESBT election, if all
the following requirements are met:
(i) The trust meets all of the
requirements to be an ESBT under
paragraph (m)(1) of this section except
for the requirement under paragraph
(m)(1)(iv)(A) of this section that the trust
not have a QSST election in effect.
(ii) The trustee and the current
income beneficiary of the trust sign the

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34397

ESBT election. The ESBT election must
be filed with the service center where
the S corporation files its income tax
return. This ESBT election must state at
the top of the document ‘‘ATTENTION
ENTITY CONTROL—CONVERSION OF
A QSST TO AN ESBT PURSUANT TO
SECTION 1.1361–1(j)’’ and include all
information otherwise required for an
ESBT election under paragraph (m)(2) of
this section. A separate election must be
made with respect to the stock of each
S corporation held by the trust.
(iii) The trust has not converted from
an ESBT to a QSST within the 36-month
period preceding the effective date of
the new ESBT election.
(iv) The date on which the ESBT
election is to be effective cannot be
more than 15 days and two months
prior to the date on which the election
is filed and cannot be more than 12
months after the date on which the
election is filed. If an election specifies
an effective date more than 15 days and
two months prior to the date on which
the election is filed, it will be effective
on the day that is 15 days and two
months prior to the date on which it is
filed. If an election specifies an effective
date more than 12 months after the date
on which the election is filed, it will be
effective on the day that is 12 months
after the date it is filed.
(k) * * *
(2) * * *
(i) * * * Paragraphs (h)(1)(vi),
(h)(3)(i)(F), (h)(3)(ii), and (j)(12) of this
section are applicable for taxable years
beginning on and after May 14, 2002.
*
*
*
*
*
(m) Electing small business trust
(ESBT)—(1) Definition—(i) General rule.
An electing small business trust (ESBT)
means any trust if it meets the following
requirements: the trust does not have as
a beneficiary any person other than an
individual, an estate, an organization
described in section 170(c)(2) through
(5), or an organization described in
section 170(c)(1) that holds a contingent
interest in such trust and is not a
potential current beneficiary; no interest
in the trust has been acquired by
purchase; and the trustee of the trust
makes a timely ESBT election for the
trust.
(ii) Qualified beneficiaries—(A) In
general. For purposes of this section, a
beneficiary includes a person who has
a present, remainder, or reversionary
interest in the trust.
(B) Distributee trusts. A distributee
trust is the beneficiary of the ESBT only
if the distributee trust is an organization
described in section 170(c)(2) or (3). In
all other situations, any person who has
a beneficial interest in a distributee trust

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is a beneficiary of the ESBT. A
distributee trust is a trust that receives
or may receive a distribution from an
ESBT, whether the rights to receive the
distribution are fixed or contingent, or
immediate or deferred.
(C) Powers of appointment. A person
in whose favor a power of appointment
could be exercised is not a beneficiary
of an ESBT until the holder of the power
of appointment actually exercises the
power in favor of such person.
(D) Nonresident aliens. A nonresident
alien as defined in section 7701(b)(1)(B)
is an eligible beneficiary of an ESBT.
However, see paragraph (m)(4)(i) and
(m)(5)(iii) of this section if the
nonresident alien is a potential current
beneficiary of the ESBT (which would
result in an ineligible shareholder and
termination of the S corporation
election).
(iii) Interests acquired by purchase. A
trust does not qualify as an ESBT if any
interest in the trust has been acquired
by purchase. Generally, if a person
acquires an interest in the trust and
thereby becomes a beneficiary of the
trust as defined in paragraph
(m)(1)(ii)(A), and any portion of the
basis in the acquired interest in the trust
is determined under section 1012, such
interest has been acquired by purchase.
This includes a net gift of a beneficial
interest in the trust, in which the person
acquiring the beneficial interest pays the
gift tax. The trust itself may acquire S
corporation stock or other property by
purchase or in a part-gift, part-sale
transaction.
(iv) Ineligible trusts. An ESBT does
not include—
(A) Any qualified subchapter S trust
(as defined in section 1361(d)(3)) if an
election under section 1361(d)(2)
applies with respect to any corporation
the stock of which is held by the trust;
(B) Any trust exempt from tax or not
subject to tax under subtitle A; or
(C) Any charitable remainder annuity
trust or charitable remainder unitrust (as
defined in section 664(d)).
(2) ESBT election—(i) In general. The
trustee of the trust must make the ESBT
election by signing and filing, with the
service center where the S corporation
files its income tax return, a statement
that meets the requirements of
paragraph (m)(2)(ii) of this section. If
there is more than one trustee, the
trustee or trustees with authority to
legally bind the trust must sign the
election statement. If any one of several
trustees can legally bind the trust, only
one trustee needs to sign the election
statement. Generally, only one ESBT
election is made for the trust, regardless
of the number of S corporations whose
stock is held by the ESBT. However, if

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the ESBT holds stock in multiple S
corporations that file in different service
centers, the ESBT election must be filed
with all the relevant service centers
where the corporations file their income
tax returns. This requirement applies
only at the time of the initial ESBT
election; if the ESBT later acquires stock
in an S corporation which files its
income tax return at a different service
center, a new ESBT election is not
required.
(ii) Election statement. The election
statement must include—
(A) The name, address, and taxpayer
identification number of the trust, the
potential current beneficiaries, and the
S corporations in which the trust
currently owns stock;
(B) An identification of the election as
an ESBT election made under section
1361(e)(3);
(C) The first date on which the trust
owned stock in each S corporation;
(D) The date on which the election is
to become effective (not earlier than 15
days and two months before the date on
which the election is filed); and
(E) Representations signed by the
trustee stating that—
(1) The trust meets the definitional
requirements of section 1361(e)(1); and
(2) All potential current beneficiaries
of the trust meet the shareholder
requirements of section 1361(b)(1).
(iii) Due date for ESBT election. The
ESBT election must be filed within the
time requirements prescribed in
paragraph (j)(6)(iii) of this section for
filing a qualified subchapter S trust
(QSST) election.
(iv) Election by a trust described in
section 1361(c)(2)(A)(ii) or (iii). A trust
that is a qualified S corporation
shareholder under section
1361(c)(2)(A)(ii) or (iii) may elect ESBT
treatment at any time during the 2-year
period described in those sections or the
16-day-and-2-month period beginning
on the date after the end of the 2-year
period. If the trust makes an ineffective
ESBT election, the trust will continue
nevertheless to qualify as an eligible S
corporation shareholder for the
remainder of the period described in
section 1361(c)(2)(A)(ii) or (iii).
(v) No protective election. A trust
cannot make a conditional ESBT
election that would be effective only in
the event the trust fails to meet the
requirements for an eligible trust
described in section 1361(c)(2)(A)(i)
through (iv). If a trust attempts to make
such a conditional ESBT election and it
fails to qualify as an eligible S
corporation shareholder under section
1361(c)(2)(A)(i) through (iv), the S
corporation election will be ineffective
or will terminate because the

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corporation will have an ineligible
shareholder. Relief may be available
under section 1362(f) for an inadvertent
ineffective S corporation election or an
inadvertent S corporation election
termination. In addition, a trust that
qualifies as an ESBT may make an ESBT
election notwithstanding that the trust
is a wholly-owned grantor trust.
(3) Effect of ESBT election—(i)
General rule. If a trust makes a valid
ESBT election, the trust will be treated
as an ESBT for purposes of chapter 1 of
the Internal Revenue Code as of the
effective date of the ESBT election.
(ii) Employer Identification Number.
An ESBT has only one employer
identification number (EIN). If an
existing trust makes an ESBT election,
the trust continues to use the EIN it
currently uses.
(iii) Taxable year. If an ESBT election
is effective on a day other than the first
day of the trust’s taxable year, the ESBT
election does not cause the trust’s
taxable year to close. The termination of
the ESBT election (including a
termination caused by a conversion of
the ESBT to a QSST) other than on the
last day of the trust’s taxable year also
does not cause the trust’s taxable year to
close. In either case, the trust files one
tax return for the taxable year.
(iv) Allocation of S corporation items.
If, during the taxable year of an S
corporation, a trust is an ESBT for part
of the year and an eligible shareholder
under section 1361(c)(2)(A)(i) through
(iv) for the rest of the year, the S
corporation items are allocated between
the two types of trusts under section
1377(a). See § 1.1377–1(a)(2)(iii).
(v) Estimated taxes. If an ESBT
election is effective on a day other than
the first day of the trust’s taxable year,
the trust is considered one trust for
purposes of estimated taxes under
section 6654.
(4) Potential current beneficiaries—(i)
In general. For purposes of determining
whether a corporation is a small
business corporation within the
meaning of section 1361(b)(1), each
potential current beneficiary of an ESBT
generally is treated as a shareholder of
the corporation. Subject to the
provisions of this paragraph (m)(4), a
potential current beneficiary generally
is, with respect to any period, any
person who at any time during such
period is entitled to, or in the discretion
of any person may receive, a
distribution from the principal or
income of the trust. A person is treated
as a shareholder of the S corporation at
any moment in time when that person
is entitled to, or in the discretion of any
person may, receive a distribution of
principal or income of the trust. No

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person is treated as a potential current
beneficiary solely because that person
holds any future interest in the trust.
(ii) Grantor trusts. If all or a portion
of an ESBT is treated as owned by a
person under subpart E, part I,
subchapter J, chapter 1 of the Internal
Revenue Code, such owner is a potential
current beneficiary in addition to
persons described in paragraph (m)(4)(i)
of this section.
(iii) Special rule for dispositions of
stock. Notwithstanding the provisions of
paragraph (m)(4)(i) of this section, if a
trust disposes of all of its S corporation
stock, any person who first met the
definition of a potential current
beneficiary during the 60-day period
ending on the date of such disposition
is not a potential current beneficiary
and thus is not a shareholder of that
corporation.
(iv) Distributee trusts—(A) In general.
This paragraph (m)(4)(iv) contains the
rules for determining who are the
potential current beneficiaries of an
ESBT if a distributee trust becomes
entitled to, or at the discretion of any
person, may receive a distribution from
principal or income of an ESBT. A
distributee trust does not include a trust
that is not currently in existence. For
this purpose, a trust is not currently in
existence if the trust has no assets and
no items of income, loss, deduction, or
credit. Thus, if a trust instrument
provides for a trust to be funded at some
future time, the future trust is not
currently a distributee trust.
(B) If the distributee trust is not a trust
described in section 1361(c)(2)(A), then
the distributee trust is the potential
current beneficiary of the ESBT and the
corporation’s S corporation election
terminates.
(C) If the distributee trust is a trust
described in section 1361(c)(2)(A), the
persons who would be its potential
current beneficiaries (as defined in
paragraphs (m)(4)(i) and (ii) of this
section) if the distributee trust were an
ESBT are treated as the potential current
beneficiaries of the ESBT.
Notwithstanding the preceding
sentence, however, if the distributee
trust is a trust described in section
1361(c)(2)(A)(ii) or (iii), the estate
described in section 1361(c)(2)(B) (ii) or
(iii) is treated as the potential current
beneficiary of the ESBT for the 2-year
period during which such trust would
be permitted as a shareholder.
(D) For the purposes of paragraph
(m)(4)(iv)(C) of this section, a trust will
be deemed to be described in section
1361(c)(2)(A) if such trust would qualify
for a QSST election under section
1361(d) or an ESBT election under

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section 1361(e) if it owned S
corporation stock.
(v) Contingent distributions. A person
who is entitled to receive a distribution
only after a specified time or upon the
occurrence of a specified event (such as
the death of the holder of a power of
appointment) is not a potential current
beneficiary until such time or the
occurrence of such event.
(vi) Currently exercisable powers of
appointment—(A) In general. A person
to whom a distribution is or may be
made during a period pursuant to a
power of appointment is a potential
current beneficiary. Thus, if any person
has a lifetime power of appointment
that would permit distributions from the
trust to be made to more than 75
persons, the corporation’s S corporation
election will terminate because the
number of potential current
beneficiaries will exceed the 75shareholder limit of section
1361(b)(1)(A). Also, the S corporation
election will terminate if the currently
exercisable power of appointment
allows distributions to be made to an
ineligible shareholder as defined in
section 1361(b)(1)(B) and (C).
(B) Waiver or release. If the holder of
a power of appointment permanently
releases the power in a manner that is
valid under applicable local law, the
persons that would be potential current
beneficiaries solely because of the
power will not be potential current
beneficiaries after the effective date of
the release. An attempt to temporarily
waive, release, or limit a currently
exercisable power of appointment will
be ignored in determining who are
potential current beneficiaries of the
trust.
(vii) Number of shareholders. Each
potential current beneficiary of the
ESBT, as defined in paragraphs (m)(4)(i)
through (vi) of this section, is counted
as a shareholder of any S corporation
whose stock is owned by the ESBT.
During any period in which the ESBT
has no potential current beneficiaries,
the ESBT is counted as the shareholder.
A person is counted as only one
shareholder of an S corporation even
though that person may be treated as a
shareholder of the S corporation by
direct ownership and through one or
more eligible trusts described in section
1361(c)(2)(A). Thus, for example, if a
person owns stock in an S corporation
and is a potential current beneficiary of
an ESBT that owns stock in the same S
corporation, that person is counted as
one shareholder of the S corporation.
Similarly, if a husband owns stock in an
S corporation and his wife is a potential
current beneficiary of an ESBT that
owns stock in the same S corporation,

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the husband and wife will be counted
as one shareholder of the S corporation.
(viii) Miscellaneous. Payments made
by an ESBT to a third party on behalf
of a beneficiary are considered to be
payments made directly to the
beneficiary. The right of a beneficiary to
assign the beneficiary’s interest to a
third party does not result in the third
party being a potential current
beneficiary until that interest is actually
assigned.
(5) ESBT terminations—(i) Ceasing to
meet ESBT requirements. A trust ceases
to be an ESBT on the first day the trust
fails to meet the definition of an ESBT
under section 1361(e). The last day the
trust is treated as an ESBT is the day
before the date on which the trust fails
to meet the definition of an ESBT.
(ii) Disposition of S stock. In general,
a trust ceases to be an ESBT on the first
day following the day the trust disposes
of all S corporation stock. However, if
the trust is using the installment method
to report income from the sale or
disposition of its stock in an S
corporation, the trust ceases to be an
ESBT on the day following the earlier of
the day the last installment payment is
received by the trust or the day the trust
disposes of the installment obligation.
(iii) Potential current beneficiaries
that are ineligible shareholders. If a
potential current beneficiary of an ESBT
is not an eligible shareholder of a small
business corporation within the
meaning of section 1361(b)(1), the S
corporation election terminates. For
example, the S corporation election will
terminate if a nonresident alien becomes
a potential current beneficiary of an
ESBT. Such a potential current
beneficiary is treated as an ineligible
shareholder beginning on the day such
person becomes a potential current
beneficiary, and the S corporation
election terminates on that date.
However, see the special rule of
paragraph (m)(4)(iii) of this section. If
the S corporation election terminates,
relief may be available under section
1362(f).
(6) Revocation of ESBT election. An
ESBT election may be revoked only
with the consent of the Commissioner.
The application for consent to revoke
the election must be submitted to the
Internal Revenue Service in the form of
a letter ruling request under the
appropriate revenue procedure.
(7) Converting an ESBT to a QSST.
For a trust that seeks to convert from an
ESBT to a QSST, the consent of the
Commissioner is hereby granted to
revoke the ESBT election as of the
effective date of the QSST election, if all
the following requirements are met:

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(i) The trust meets all of the
requirements to be a QSST under
section 1361(d).
(ii) The trustee and the current
income beneficiary of the trust sign the
QSST election. The QSST election must
be filed with the service center where
the S corporation files its income tax
return. This QSST election must state at
the top of the document ATTENTION
ENTITY CONTROL—CONVERSION OF
AN ESBT TO A QSST PURSUANT TO
SECTION 1.1361–1(m)’’ and include all
information otherwise required for a
QSST election under § 1.1361–1(j)(6). A
separate QSST election must be made
with respect to the stock of each S
corporation held by the trust.
(iii) The trust has not converted from
a QSST to an ESBT within the 36-month
period preceding the effective date of
the new QSST election.
(iv) The date on which the QSST
election is to be effective cannot be
more than 15 days and two months
prior to the date on which the election
is filed and cannot be more than 12
months after the date on which the
election is filed. If an election specifies
an effective date more than 15 days and
two months prior to the date on which
the election is filed, it will be effective
on the day that is 15 days and two
months prior to the date on which it is
filed. If an election specifies an effective
date more than 12 months after the date
on which the election is filed, it will be
effective on the day that is 12 months
after the date it is filed.
(8) Examples. The provisions of this
paragraph (m) are illustrated by the
following examples in which it is
assumed, unless otherwise specified,
that all noncorporate persons are
citizens or residents of the United
States:
Example 1. (i) ESBT election with section
663(c) separate shares. On January 1, 2003,
M contributes S corporation stock to Trust for
the benefit of M’s three children A, B, and C.
Pursuant to section 663(c), each of Trust’s
separate shares for A, B, and C will be treated
as separate trusts for purposes of determining
the amount of distributable net income (DNI)
in the application of sections 661 and 662.
On January 15, 2003, the trustee of Trust files
a valid ESBT election for Trust effective
January 1, 2003. Trust will be treated as a
single ESBT and will have a single S portion
taxable under section 641(c).
(ii) ESBT acquires stock of an additional S
corporation. On February 15, 2003, Trust
acquires stock of an additional S corporation.
Because Trust is already an ESBT, Trust does
not need to make an additional ESBT
election.
(iii) Section 663(c) shares of ESBT convert
to separate QSSTs. Effective January 1, 2004,
A, B, C, and Trust’s trustee elect to convert
each separate share of Trust into a separate
QSST pursuant to paragraph (m)(7) of this

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section. For each separate share, they file a
separate election for each S corporation
whose stock is held by Trust. Each separate
share will be treated as a separate QSST.
Example 2. (i) Invalid potential current
beneficiary. Effective January 1, 2003, Trust
makes a valid ESBT election. On January 1,
2004, A, a nonresident alien, becomes a
potential current beneficiary of Trust. Trust
does not dispose of all of its S corporation
stock within 60 days after January 1, 2004.
As of January 1, 2004, A is a potential current
beneficiary of Trust and therefore is treated
as a shareholder of the S corporation.
Because A is not an eligible shareholder of
an S corporation under section 1361(b)(1),
the S corporation election of any corporation
in which Trust holds stock terminates
effective January 1, 2004. Relief may be
available under section 1362(f).
(ii) Invalid potential current beneficiary
and disposition of S stock. Assume the same
facts as in Example 2 (i) except that within
60 days after January 1, 2004, trustee of Trust
disposes of all Trust’s S corporation stock. A
is not considered a potential current
beneficiary of Trust and therefore is not
treated as a shareholder of any S corporation
in which Trust previously held stock.
Example 3. Subpart E trust. M transfers
stock in X, an S corporation, and other assets
to Trust for the benefit of B and B’s siblings.
M retains no powers or interest in Trust.
Under section 678(a), B is treated as the
owner of a portion of Trust that includes a
portion of the X stock. No beneficiary has
acquired any portion of his or her interest in
Trust by purchase, and Trust is not an
ineligible trust under paragraph (m)(1)(iv) of
this section. Trust is eligible to make an
ESBT election.
Example 4. Subpart E trust continuing after
grantor’s death. On January 1, 2003, M
transfers stock in X, an S corporation, and
other assets to Trust. Under the terms of
Trust, the trustee of Trust has complete
discretion to distribute the income or
principal to M during M’s lifetime and to M’s
children upon M’s death. During M’s life, M
is treated as the owner of Trust under section
677. The trustee of Trust makes a valid
election to treat Trust as an ESBT effective
January 1, 2003. On March 28, 2004, M dies.
Under applicable local law, Trust does not
terminate on M’s death. Trust continues to be
an ESBT after M’s death, and no additional
ESBT election needs to be filed for Trust after
M’s death.
Example 5. Potential current beneficiaries
and distributee trust holding S corporation
stock. Trust-1 has a valid ESBT election in
effect. The trustee of Trust-1 has the power
to make distributions to A directly or to any
trust created for the benefit of A. On January
1, 2003, M creates Trust-2 for the benefit of
A. Also on January 1, 2003, the trustee of
Trust-1 distributes some S corporation stock
to Trust-2. A, as the current income
beneficiary of Trust-2, makes a timely and
effective election to treat Trust-2 as a QSST.
Because Trust-2 is a valid S corporation
shareholder, the distribution to Trust-2 does
not terminate the ESBT election of Trust-1.
Trust-2 itself will not be counted toward the
75-shareholder limit of section 1361(b)(1)(A).
Additionally, because A is already counted

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as an S corporation shareholder because of
A’s status as a potential current income
beneficiary of Trust-1, A is not counted again
by reason of A’s status as the deemed owner
of Trust-2.
Example 6. Potential current beneficiaries
and distributee trust not holding S
corporation stock. (i) Distributee trust that
would itself qualify as an ESBT. Trust-1
holds stock in X, an S corporation, and has
a valid ESBT election in effect. Under the
terms of Trust-1, the trustee has discretion to
make distributions to A, B, and Trust-2, a
trust for the benefit of C, D, and E. Trust-2
would qualify to be an ESBT, but it owns no
S corporation stock and has made no ESBT
election. Under paragraph (m)(4)(iv) of this
section, Trust-2’s potential current
beneficiaries are treated as the potential
current beneficiaries of Trust-1 and are
counted as shareholders for purposes of
section 1361(b)(1). Thus, A, B, C, D, and E
are potential current beneficiaries of Trust-1
and are counted as shareholders for purposes
of section 1361(b)(1). Trust-2 itself will not
be counted as a shareholder of Trust-1 for
purposes of section 1361(b)(1).
(ii) Distributee trust that would not qualify
as an ESBT or a QSST. Assume the same
facts as in paragraph (i) of this Example 6
except that D is a nonresident alien. Trust2 would not be eligible to make an ESBT or
QSST election if it owned S corporation
stock and therefore Trust-2 is a potential
current beneficiary of Trust-1. Since Trust-2
is not an eligible shareholder, X’s S
corporation election terminates.
(iii) Distributee trust that is a section
1361(c)(2)(A)(ii) trust. Assume the same facts
as in paragraph (i) of this Example 6 except
that Trust-2 is a trust treated as owned by A
under section 676 because A has the power
to revoke Trust-2 at any time prior to A’s
death. On January 1, 2003, A dies. Because
Trust-2 is a trust described in section
1361(c)(2)(A)(ii) during the 2-year period
beginning on the day of A’s death, under
paragraph (m)(4)(iv)(C) of this section, Trust2’s only potential current beneficiary is the
person listed in section 1361(c)(2)(B)(ii), A’s
estate. Thus, B and A’s estate are potential
current beneficiaries of Trust-1 and are
counted as shareholders for purposes of
section 1361(b)(1).
Example 7. Potential current beneficiaries
and powers of appointment. M creates Trust
for the benefit of A. A also has a currently
exercisable power to appoint income or
principal to anyone except A, A’s creditors,
A’s estate, and the creditors of A’s estate. The
potential current beneficiaries of Trust will
be A and all other persons except for A’s
creditors, A’s estate, and the creditors of A’s
estate. This number will exceed the 75shareholder limit of section 1361(b)(1)(A). If
Trust holds S corporation stock, the
corporation’s S election will terminate.

(9) Effective date. This paragraph (m)
is applicable for taxable years of ESBTs
beginning on and after May 14, 2002.
Par. 7. Section 1.1362–6 is amended
by revising paragraph (b)(2)(iv) to read
as follows:
§ 1.1362–6

Election and consents.

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(b) * * *
(2) * * *
(iv) Trusts. In the case of a trust
described in section 1361(c)(2)(A)
(including a trust treated under section
1361(d)(1)(A) as a trust described in
section 1361(c)(2)(A)(i) and excepting
an electing small business trust
described in section 1361(c)(2)(A)(v)
(ESBT)), only the person treated as the
shareholder for purposes of section
1361(b)(1) must consent to the election.
When stock of the corporation is held by
a trust, both husband and wife must
consent to any election if the husband
and wife have a community interest in
the trust property. See paragraph
(b)(2)(i) of this section for rules
concerning community interests in S
corporation stock. In the case of an
ESBT, the trustee and the owner of any
portion of the trust that consists of the
stock in one or more S corporations
under subpart E, part I, subchapter J,
chapter 1 of the Internal Revenue Code
must consent to the S corporation
election. If there is more than one
trustee, the trustee or trustees with
authority to legally bind the trust must
consent to the S corporation election.
*
*
*
*
*
Par. 8. Section 1.1362–7 is amended
by:
1. Revising the section heading.
2. Adding a sentence to the end of
paragraph (a).
The revision and addition read as
follows:
§ 1.1362–7

Effective dates.

(a) * * * Section 1.1362–6(b)(2)(iv) is
applicable for taxable years beginning
on and after May 14, 2002.
*
*
*
*
*
Par. 9. Section 1.1377–0 is amended
by adding an entry for § 1.1377–
1(a)(2)(iii) to read as follows:
§ 1.1377–0

Table of contents.

*

*

*

*

*

*
*
*
*
Par. 10. Section 1.1377–1 is amended
by:
1. Adding paragraph (a)(2)(iii).
2. Adding Example 3 to paragraph (c).
The additions read as follows:
Pro rata share.

(a) * * *
(2) * * *
(iii) Shareholder trust conversions. If,
during the taxable year of an S
corporation, a trust that is an eligible

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Example 3. Effect of conversion of a
qualified subchapter S trust (QSST) to an
electing small business trust (ESBT). (i) On
January 1, 2003, Trust receives stock of S
corporation. Trust’s current income
beneficiary makes a timely QSST election
under section 1361(d)(2), effective January 1,
2003. Subsequently, the trustee and current
income beneficiary of Trust elect, pursuant to
§ 1.1361–1(j)(12), to terminate the QSST
election and convert to an ESBT, effective
July 1, 2004. The taxable year of S
corporation is the calendar year. In 2004,
Trust’s pro rata share of S corporation’s
nonseparately computed income is $100,000.
(ii) For purposes of computing the income
allocable to the QSST and to the ESBT, Trust
is treated as a QSST through June 30, 2004,
and Trust is treated as an ESBT beginning
July 1, 2004. Pursuant to section 1377(a)(1),
the pro rata share of S corporation income
allocated to the QSST is $49,727 ($100,000
x 182 days/366 days), and the pro rata share
of S corporation income allocated to the
ESBT is $50,273 ($100,000 x 184 days/366
days).

Par. 11. Section 1.1377–3 is revised to
read as follows:
§ 1.1377–3

*

§ 1.1377–1 Pro rata share.
(a) * * *
(2) * * *
(iii) Shareholder trust conversions.

§ 1.1377–1

shareholder of the S corporation
converts from a trust described in
section 1361(c)(2)(A)(i), (ii), (iii), or (v)
for the first part of the year to a trust
described in a different subpart of
section 1361(c)(2)(A)(i), (ii), or (v) for
the remainder of the year, the trust’s
share of the S corporation items is
allocated between the two types of
trusts. The first day that a qualified
subchapter S trust (QSST) or an electing
small business trust (ESBT) is treated as
an S corporation shareholder is the
effective date of the QSST or ESBT
election. Upon the conversion, the trust
is not treated as terminating its entire
interest in the S corporation for
purposes of paragraph (b) of this
section, unless the trust was a trust
described in section 1361(c)(2)(A)(ii) or
(iii) before the conversion.
*
*
*
*
*
(c) * * *

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Effective dates.

Section 1.1377–1 and 1.1377–2 apply
to taxable years of an S corporation
beginning after December 31, 1996,
except that § 1.1377–1(a)(2)(iii), and (c)
Example 3 are applicable for taxable
years beginning on and after May 14,
2002.
PART 602—OMB CONTROL NUMBERS
UNDER THE PAPERWORK
REDUCTION ACT
Par. 12. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.

Par. 13. In § 602.101, paragraph (b) is
amended by adding an entry for 1.444–
4 and revising the entry for 1.1361–1 in

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numerical order to the table to read as
follows:
§ 602.101

*

OMB Control numbers.

*
*
(b) * * *

*

*

CFR part or section where
identified and described

Current OMB
control No.

*
*
*
*
1.444–4 .................................

*
1545–1591

*
*
*
*
1.1361–1 ...............................

*
1545–0731
1545–1591

*

*

*

*

*

Approved: May 3, 2002.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Pamela Olson,
Acting Assistant Secretary of the Treasury.
[FR Doc. 02–11791 Filed 5–13–02; 8:45 am]
BILLING CODE 4830–01–P

DEPARTMENT OF THE TREASURY
31 CFR Part 1
Departmental Offices; Disclosure of
Records; Freedom of Information Act
and Privacy Act of 1974;
Implementation
Department of the Treasury.
Final rule.

AGENCY:
ACTION:

SUMMARY: The Department of the
Treasury is amending its regulations
concerning the Freedom of Information
Act (FOIA), and the Privacy Act,
(Privacy Act), by revising regulations to
specify new addresses for the Bureau of
the Public Debt. We are also identifying
a new official responsible for
administrative appeals of initial
determinations.
EFFECTIVE DATE:

May 14, 2002.

FOR FURTHER INFORMATION CONTACT:

Edward C. Gronseth, Deputy Chief
Counsel, Office of the Chief Counsel,
Bureau of the Public Debt, at (304) 480–
8692, [email protected]
or Elizabeth S. Gracia, Senior Attorney,
Office of the Chief Counsel, Bureau of
the Public Debt, at (304) 480–8692,
[email protected].
The
Bureau of the Public Debt has decided
to move its FOIA and Privacy Act
program responsibilities to Parkersburg,
West Virginia. We are providing the
proper addresses where the public may

SUPPLEMENTARY INFORMATION:

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