S Corporations With Foreign Owners

The 2017 Tax Cuts and Jobs Act changed the rules dramatically with respect to S corporations in one particular: non-citizen non-resident shareholders. Before the change, non-citizen non-residents of the U.S. could not own S corporation stock. Period. Even marrying into S corporation stock, or getting it from a deceased relative, would violate the rule for the non-citizen non-resident. The consequence or violating the old rule was the S corporation would become a C corporation and would be subjected to double taxation–corporate tax at the corporate level and dividend tax at the shareholder level. That was a bad result.

Tucked into a corner of the 2017 Act, however, was an exception. A non-citizen non-resident can now own S corporation stock if the stock is held in an electing small business trust (and “ESBT”) of which the non-citizen non-resident is a beneficiary. The trade off is an ESBT must pay tax on all of the income it gets from the S corporation at the trust level, but, having a non-citizen non-resident beneficiary does not turn the S corporation into a C corporation.

It might be obvious, but arranging for an ESBT to hold the stock for a non-citizen non-resident takes a bit of foresight. The ESBT needs to be formed, and it needs to make appropriate tax elections.

But, for cross-border families that own S corporations, this is a big change. Imagine, for example, that parents own a business through an S corporation, and they have two children: one that is a US citizen and the other that is a non-US citizen who is a resident of the UK. Before the change, the parents could not leave the business to the non-US citizen child without losing S corporation status. Now, by placing the non-US citizen child’s shares in an ESBT, they can leave the business to the children equally and the tax treatment of the corporation does not change.

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