Planning for a QSSS.
Sec. 1361(b)(3)(A) now allows an S corporation to own a qualified subchapter S subsidiary (QSSS). Sec. 1361(b)(3)(B) defines a QSSS as a domestic corporation that is not an "ineligible corporation" if an S corporation holds 100% of that corporation's stock and it elects to treat that subsidiary as a QSSS.
Ineligible corporations include:
* Financial institutions using the reserve method for bad debts described in Sec. 585;
* Insurance companies subject to tax under Subchapter L;
* Corporations subject to a Sec. 936 election; or
* Domestic international sales corporations (DISCs) or former DISCs.
By repealing former Sec. 1361(b)(2)(A), the SBJPA permits an S corporation to own 80% or more of a C corporation. At the same time, new Sec. 1504(b)(8) prevents an S corporation from joining in a consolidated return with its affiliated C corporations. However, the C corporation subsidiary may elect to join in the filing of a consolidated return with its affiliated C corporations.
Under prior law, the S election of a corporation with earnings and profits (E&P) accumulated as a C corporation terminated if the S corporation received passive investment income (including dividends) exceeding 25% of gross receipts for three consecutive years. Sec. 1362(d)(3)(E) modifies this rule by excluding dividends from an 80%-or-more-owned C corporation to the extent they are attributable to that C corporation's E&P derived from the active conduct of a trade or business.
However, neither the law nor its legislative history provides rules for determining the attribution of dividends to an active trade or business. It would seem that Sec. 316(a) would apply to require that a distribution be treated as having been made out of the most recently accumulated E&P, including current E&P when there is no accumulated E&P.
The QSSS will not be treated as a separate corporation for Federal income tax purposes. Under Sec. 1361(b)(3)(A), its assets, liabilities, items of income, deduction and credit will be treated as belonging to the parent S corporation. However, the statute does not specify how the S corporation makes this election, its effective date, or how the commingling of assets, liabilities and other items occurs after the election is made.
The QSSS rules may apply not only to a direct wholly owned subsidiary of an electing S corporation, but also to other wholly owned eligible subsidiaries in a chain below that direct subsidiary. Because the direct subsidiary's assets are treated as the S parent's assets, all of a lower-tier subsidiary's stock will be deemed to be owned by the electing S corporation. A QSSS election may be made for each member of that chain. A QSSS election does not have to be made for all subsidiaries eligible for this election. However, a break in the chain of elections will preclude QSSS treatment for lower-tier subsidiaries.
Example: X Corp. is an S corporation that owns 100% of the stock of Y Corp., which, in turn, owns 100% of the stock of Z Corp. If Y is a QSSS, Z may be (but does not have to be) a QSSS. However, if Y is not a QSSS, Z may not be a QSSS.
Observation: There is no authority as to whether some of a QSSS's stock may be held partially by an S corporation and the remainder by another QSSS. Arguably, this should be permitted, since a QSSS's assets are treated as held by an S corporation under Sec. 1361(b)(3)(A)(11).
A foreign subsidiary cannot qualify as a QSSS. However, an S corporation can now hold any percentage interest in a foreign corporation. If flow-through treatment is desirable, the parent S corporation should consider using a foreign partnership or a wholly owned foreign limited liability company under the check-the-box rules (Regs. Secs. 301.7701-1-3).
QSSS Election and Deemed Liquidation
The legislative history of SBJPA Section 1308 indicates that when a parent makes an election to treat a subsidiary as a QSSS, the subsidiary will be deemed to have liquidated under Secs. 332 and 337 immediately before the election is effective (Notice 97-4).
A Sec. 332 liquidation provides nonrecognition of gain or loss and a carryover of basis and other tax attributes, including E&P; the parents basis in the subsidiary's stock disappears. However, when the subsidiary has been a C corporation, Sec. 1374(d)(8) applies; any net built-in gain attributable to the subsidiary's assets is taxed to the corporation if recognized during the 10-year recognition period. In addition, Sec. 1363(d) recaptures the subsidiary's LIFO benefits.
When a corporation liquidates under Sec. 332, it must file Form 966, Corporate Dissolution or Liquidation, within 30 days of adopting a liquidating plan or resolution. The corporation also must file a final income tax return for the short period ending on the date it goes out of existence.
The IRS and Treasury intend to issue regulations describing the manner in which a QSSS election must be made and the election's effective date. However, until regulations are issued, taxpayers should follow the procedures listed in Notice 97-4 to satisfy the election requirements.
Termination of QSSS Status
Under Sec. 1361(b)(3)(C), if a QSSS ceases to meet Sec. 1.361(b)(3)(B)'s requirements, it will be treated as a new corporation acquiring all of its assets (and assuming all of its liabilities) immediately before the cessation from its S parent in a deemed exchange for the subsidiary's stock.
This deemed asset transfer (pursuant to such termination) would result in gain nonrecognition to the parent under Sec. 351. Gain recognition would occur under Sec. 357(c) to the extent the liabilities assumed by the subsidiary exceed the parent's basis in the assets transferred to the subsidiary. Any gain recognized by the parent is considered a gain from the parent's deemed sale of or exchange of those assets.
If a subsidiary ceases to be a QSSS, either because it falls to qualify or its parent revokes the election, another QSSS election or S election cannot be made for that subsidiary (and any successor corporation) by the parent (or its shareholders) for five years without IRS consent (Sec. 1361(b)(3)(D)).
Business and Planning Significance
These new rules enable taxpayers to place different trades or business in different corporations, for liability, financing or other business reasons, and still obtain passthrough treatment for tax purposes. State income tax laws should be reviewed to determine if a relevant state will follow the Federal income tax treatment. In addition, some states may impose entity-level taxes on all businesses.
To make the QSSS election, the parent should file Form 966 with the service center. When completing this form, the parent should follow the applicable instructions, with the following modifications:
1. At the top of Form 966, print "FILED PURSUANT TO NOTICE 97-4."
2. In the box labeled "Employer identification number" (EIN), enter the subsidiary's EIN (if applicable). If the subsidiary was not in existence before the election and does not have an EIN, there will be no need to obtain an EIN for the subsidiary. In this case, insert "QSSS" in the box. (If the parent chooses to obtain an EIN for the newly formed QSSS, the parent should check "Other" when asked the "Type of entity" on Form SS-4 and specify that the entity is a QSSS.)
3. In Box 4 on Form 966, enter the election's desired effective date. The election may be effective on the date Form 966 is filed or up to 75 days before the filing of Form 966, provided that date is not before SBJPA Section 1308's effective date (tax years beginning after 1996) and the subsidiary otherwise qualified as a QSSS for the entire period for which the retroactive election is in effect. For these purposes, the requirement that Form 966 be filed within 30 days of the date in Box 4 is ignored.
4. In Box 7c on Form 966, enter the parent's name. The parent's EIN should be included in Box 7d.
5. In Box 10 on Form 966, enter "Section 1361(b)(3)(B)."
6. Form 966 must be signed by a corporate officer authorized to sign the parent's tax return.
Banks and bank holding companies should consult Notice 97-5 before filing this election.
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|Title Annotation:||qualified Internal Revenue Code Subchapter S subsidiaries|
|Author:||Huizenga, David L.|
|Publication:||The Tax Adviser|
|Date:||May 1, 1998|
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