Operating a QSub.

• Author: Ellentuck, Albert B.
• Position: Qualified subchapter S subsidiary

A QUALIFIED SUBCHAPTER S SUBSIDIARY (QSUB) is a subsidiary corporation 100% owned by an S corporation that has made a valid QSub election for the subsidiary (Sec. 1361(b)(3)(B)). Because a QSub's separate existence is ignored, transactions between the S corporation parent and QSub are not taken into account, and items of the subsidiary (including accumulated earnings and profits, passive investment income, and built-in gains) are considered items of the parent. The QSub election terminates the QSub's former identity as a separate entity for federal tax purposes. Thus, a final income tax return must be filed. This final return generally includes the deemed liquidation transaction.

A QSub is normally treated as a disregarded entity for all purposes of the Code (Secs. 1361(b)(3)(A)(i) and (ii)). However, the IRS is authorized to treat it as a separate entity for certain purposes (Sec. 1361(b)(3)(A)).

Under this authority, the IRS has issued regulations that treat QSubs as separate entities for the following purposes: (1) employment taxes; (2) certain federal liabilities, refunds, and credits of federal tax; and (3) certain excise taxes.

QSub Treated Separately for Employment Taxes

For wages paid after 2008, a QSub is treated as a separate entity for federal employment taxes (Regs. Sec. 1.1361-4(a) (7)). Accordingly, the QSub is liable for employment taxes on wages paid to its employees and is responsible for satisfying its other employment tax obligations (e.g., backup withholding, making timely deposits of employment taxes, filing returns, and providing wage statements to its employees on Forms W-2, Wage and Tax Statement). The parent S corporation is separately responsible for employment taxes on wages paid to its employees and is separately responsible for satisfying its other employment tax obligations.

Related corporations may avoid the overpayment of employment taxes for common employees by implementing a common paymaster system. If two or more related corporations concurrently employ the same worker and pay him or her through a common paymaster that is one of the related corporations, only the common paymaster corporation must withhold and pay employer FICA and FUTA taxes (Secs. 3121(s) and 3306(p)). If all wages of the concurrently employed worker are disbursed by the common paymaster, the group of corporations pays no more employer tax than would a single employer.

To implement a common paymaster system, the corporations must (1) be appropriately related, (2) concurrently employ workers, and (3) authorize one of the corporations to be the common paymaster (Regs. Secs. 31.3121(s)-1 and 31.3306(p)-1(a)). While there is no direct authority on point, it would appear that an S...