Affiliated group members may elect S status under the SBJPA.

Under pre-Small Business job Protection Act of 1996 (SBJPA) law, a corporation that was a member of an affiliated group was prohibited from electing S status. Although there were numerous methods of breaking affiliation, those methods generally resulted in the loss of liability protection afforded by maintaining operations in separate legal entities or income recognition at the corporate and/or shareholder level. However, a provision of the SBJPA addressed these problems by repealing the prohibition.

Under the new rule, an S corporation can have 100%-owned subsidiaries (both domestic and foreign). In addition, a subsidiary wholly owned by a parent S corporation can elect to be a qualified subchapter S subsidiary (QSSS). A QSSS is not treated as a separate corporation; all of its assets, liabilities, income items, deductions and credits are treated as those of the parent S corporation (i.e., the QSSS is essentially treated as a division of the parent S corporation). It appears that an S corporation can have multiple tiers of QSSSs (e.g., a subsidiary of a QSSS may also be a QSSS).

Upon electing QSSS status, the subsidiary is treated as liquidating under Secs. 332 and 337 immediately before the election is effective. The built-in gains tax and the LIFO recapture tax may apply if the subsidiary was previously a C corporation. (Note: The new law also clarifies that an S corporation is eligible to use Sec. 332 in liquidating a subsidiary, and join in a Sec. 338(g) or (h)(10) election on the purchase of a subsidiary.)

Under the new law, there is an opportunity to "mix and match" S corporations and C corporations within a business's organizational structure to maximize Federal, state and local, and international tax benefits. For example, if an S corporation is planning to see an asset subject to the built-in gains tax, shareholder-level tax on the gain may be deferred by contributing the asset to a C corporation. In addition, C corporation subsidiaries could be used to recognize state and local tax benefits and/or to reduce the corporation's and shareholder's compliance burdens. For example, if product set-up and delivery and/or warranty work are the activities creating multi-state nexus, it may be possible to move these operations into a C corporation subsidiary so that only the C corporation need file within a state. It may also be possible to achieve international tax savings by having an S corporation own foreign subsidiaries (e.g., as compared to branches).