The Intersection of S Corps., ESBTs, California Tax and Beer

Aug 10, 2022 | Business Planning, General Estate Planning, Podcasts, T&E Administration, Uniform Law, Multi-State Issues & Laws

“The Intersection of S Corps, ESBTs, California Tax and Beer,” that’s the subject of this week’s ACTEC’s Trust and Estate Talk. 

Transcript/Show Notes

This is Travis Hayes  ACTEC Fellow from Naples, Florida. Like all of you, I can’t wait to hear about how S Corporations, ESBTs, California tax, and beer tie in together. Today, we are joined by ACTEC Fellow Justin Miller from San Francisco who will enlighten us on how these four topics intersect. Welcome to Justin.

Irrevocable Non-Grantor Trust

Well, thank you, Travis. I’m going to go ahead and start with the moral of the story, and that is, when it comes to trust planning sometimes you can do everything right and you still might be subject to tax in California. So, let’s just say you have an S Corporation and you want to do some planning for gift and estate tax purposes, as well as save state income taxes. One option to consider could be to create an irrevocable non-grantor trust in a state without state income taxes. Now, not every non-grantor trust is allowed to be an owner of an S Corporation. That non-grantor trust would need to be either a Qualified Subchapter S trust, or QSST, or an Electing Small Business Trust, or ESBT, often pronounced “es-bit”.

And, even if you get past that hurdle, you still don’t automatically avoid state income taxes. So, for a state like California, to avoid state income taxes with a non-grantor trust you also would need to avoid three things: 1) having any fiduciaries in California; 2) having any non-contingent beneficiaries in California; and 3) having any California source income. All right, so, where do S Corps, ESBTs, California tax, and beer all come together? Well, that brings up the recent case of Metropoulos v. The California FTB

California ESBT & S Corp

So, as a bit of background, Dean Metropoulos is a food industry executive. He’s famous for making billions flipping food and beverage companies. And, in 2010, he bought Pabst Beer for a recorded $250 million, and then he turned around and sold it a few years later in 2014 for an estimated $700 to $750 million. So, that’s not bad; roughly tripling your investment in less than four years. Now, for those of you who aren’t familiar with Pabst Beer, at one point -all the way back in 1980 – it was third in beer sales in the U.S. However, over the next couple of decades sales went from 18 million barrels a year to less than a million barrels. However, in the 2000s, Pabst began to make a comeback. Its signature beer, Pabst Blue Ribbon, which is affectionately called PBR for short, actually became a cool, cheap canned beer for hipsters. So, it made a comeback.

Meanwhile, Dean Metropoulos had done some strategic trust planning. He created a couple irrevocable non-grantor trusts for his family under Delaware law, which happens to have some great trust laws, strong asset protection, and no state income tax for trusts with non-Delaware residents. Those trusts then ended up owning more than half of the Pabst parent S Corporation. And the trust, at least according to the Metropoulos case, seemed to do everything right in terms of planning. They made appropriate ESBT elections. There were no California fiduciaries. And since they were fully discretionary trusts, there were no California non-contingent beneficiaries. So, the final hurdle to avoid California state income tax was that there couldn’t be any California source income.

S Corps and California Entity Tax

All right. So, what happened when the Pabst S Corporation sold its wholly owned subsidiary, Pabst Holdings Inc., in 2014? Well, first let’s start at the S Corporation level. Now, even though S Corporations are pass-through entities for federal tax purposes, there is an entity level tax on the S Corporation for California state income tax purposes.

It’s a 1.5% tax on California-sourced income with a minimum $800 tax per year. Now, when the Pabst Holding subsidiary was sold, the Pabst S Corporation parent allocated 99% of the long-term capital gain as the sale of goodwill. And since Pabst did business all over the country, it then allocated 6.6% of that income to California at the entity level. So, that’s the entity level tax; the S Corporation entity level tax for California tax purposes.

Now, the big question, in this case, was whether an irrevocable, non-grantor, non-resident trust in another state should also have to pay California state income tax on the proceeds that flowed through the S Corporation to the shareholders that weren’t even residents of California.

Mobilia Rule and the Business Situs Exception

The argument for the Delaware trust was that, when it comes to intangible income like goodwill, there’s this common law principle called the mobilia rule, or mobilia sequuntur personam for those of you who like Latin and can excuse my pronunciation. Anyway, the mobilia rule basically says that intangible property has a taxable situs at the domicile of the owner, not where the entity is located. So, in the case of the Delaware trust, arguably the intangible income should have been sourced in Delaware with the Delaware owners as opposed to California.

However, and this is a big however, there is an exception to the mobilia rule if the intangible income acquires a “business situs in California.” Now, the Court of Appeal focused on the fact that the Pabst Corporation Headquarters and the marketing and sales departments were in California, and that at the entity level, it already allocated 6.6% of its income to California, and that was enough to give the goodwill “business situs in California” as an exception to that mobilia rule. So, as a result, even though the trust did everything they could to stay out of California’s tax system, they were still subject to tax on the portion of California source income that flowed through the S Corp.


It kind of reminds me of that quote from The Godfather, “Just when I thought I was out, they pull me back in.” So, you may be thinking, “What could have possibly been done differently to avoid the California tax?” Well, from the planning perspective, perhaps the two Delaware ESBTs could have received more favorable California state income tax results if they had sold their stock in the Pabst parent S Corporation directly before the Pabst S Corporation sold its interest in the wholly-owned subsidiary in an asset sale. Then again, that might not have been an option in the transaction with the buyers.

But it is a possible planning idea to avoid California income tax flowing through the S Corporation. So, with that, I want to wish everyone the best of luck with their trust, estate, and income tax planning. Thank you and have a great day.

Thank you, Justin, for speaking to us today about the intersection of S Corps, ESBTs, California tax, and my favorite topic, beer.

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