“Qualified Subchapter S Subsidiaries”		«BACK
	by Scott Husaby
	from Krass Monroe, P.A.

Once a valid QSSS election has been made, the subsidiary will not be treated as a separate corporation for federal income tax purposes. Under I.R.C. '1361(b)(3)(A) its assets, liabilities, items of income, deduction and credit (including accumulated earnings and profits, passive investment income, built-in gains, etc.) will be treated as belonging to the parent S corporation. While the exact details of this treatment remain to be worked out in guidance from the IRS, some direction is provided in the legislative history. The Senate Report provides that transactions between the parent and subsidiary are not to be taken into account and all tax attributes of the subsidiary are to be treated as belonging to the parent. S. Rep't No. 104-281, 104th Cong., 2d Sess. 54-55 (1996). Debt issued by a QSSS to a shareholder of the parent will be treated as debt of the parent under I.R.C. ' 1366(d)(1)(B), thus permitting losses to flow through to that extent. The losses of the subsidiary can be suspended when the losses of the parent are not, because the shareholder might be at risk under state law and contract with respect to one and not the other. (Treasury has been directed to specify the order in which losses pass through when both parent and subsidiary debt are held by the shareholder.) Commentators have speculated that the provisions of I.R.C ' 856(i), concerning REIT subsidiaries, may be analogous to the QSSS situation. If this speculation is accurate, the merger of another corporation into a QSSS would be treated as a merger into the parent. See PLR 9411035 (merger of REIT subsidiaries treated as merger into parent REIT).

The cleanest mechanism for establishing a QSSS obviously entails setting up a new corporation. This scenario is preferred because the Act is silent as to what will happen when a pre-existing corporation becomes a QSSS. Based on the legislative history of earlier versions of the bill, however, the QSSS election will likely be viewed as a liquidation of the subsidiary under I.R.C. ''332 and 337. The Act did not specify a timing mechanism for making the election for a QSSS. It is hoped that the IRS will provide that the election can be made for a newly-created subsidiary of an S corporation within the same period after the beginning of its initial tax year as is required for the S election itself (i.e., within 2 1/2 months of the beginning of the tax year). Assuming the Service adopts this position, the subsidiary will never have been either a C corporation or an independent electing S corporation and, presumably, no deemed liquidation will be necessary.

If a subsidiary ceases to be a QSSS, it will be treated as a new corporation acquiring all of its assets immediately before such cessation from the parent S corporation in exchange for its stock. I.R.C. ' 1361(b)(3)(C). After termination of its status as a QSSS, a 5-year prohibition applies during which the parent cannot re-elect QSSS status for the subsidiary and the subsidiary cannot make its own S election. I.R.C. ' 1361(b)(3)(D).

Whether restructuring your current business structure to add a QSSS would be advantageous depends upon your particular facts and circumstances. As a general matter, a QSSS can add significant tax benefits to a family of businesses when some entities typically generate taxable income while other entities generate taxable losses. Utilization of a QSSS may allow the income and losses to offset one another. In addition, a QSSS can be utilized as a successful asset protection vehicle. By transferring assets used in a business line to a QSSS, the parent company and its owners can be protected from certain liabilities/claims associated with the transferred assets and operation in which they are used.