QSSS prop. regs.

• Author: Schwartzman, Randy
• Position: IRS proposed regulations concerning qualified Subchapter S subsidiary corporations

A qualified subchapter S subsidiary (QSSS) is generally any eligible domestic corporation owned 100% by an S corporation parent for which a timely QSSS election is made. Most domestic corporations that are wholly owned S subsidiaries are eligible, except for financial institutions using the reserve method of accounting for bad debts, insurance companies, current or former domestic international sales corporations, corporations subject to the possessions credit provisions and foreign corporations.

The QSSS provisions originated as part of the Small Business Job Protection Act of 1996 (SBJPA). Prior to the SBJPA, affiliated groups could not elect S status, because an S corporation could not have a corporate shareholder or own 80% or more of another corporation. Although S corporations are still restricted from having corporate shareholders, S corporations may now own 80% or more of other corporations.

Subchapter C clients that have 80%-or-more-owned corporate subsidiaries can now elect S status for themselves and for selected wholly owned subsidiaries. Once the common parent of an affiliated group elects S status, it can select which subsidiary to treat as a QSSS, if the subsidiaries are held as brothers and sisters. While QSSS status would not be desirable for profitable subsidiaries that have separate return limitation year net operating losses or tax credits, it would be desirable for profitable subsidiaries without any such tax attributes.

S clients can also benefit from these provisions. Complex brother-sister type arrangements formed for nontax purposes, such as segregating potential liabilities of one corporation from the assets of another corporation, can be eliminated. Moreover, S clients now have the ability to seek acquisitions of more than 79% of other corporations (other than for momentary ownership), without the need for immediate liquidation.

Prop. Regs. Sec. 1.1361-4 was issued last spring, providing taxpayers with the IRS's interpretation of the new tax law. This regulation is generally taxpayer friendly, easy to understand and contains many examples. Its rules address eligibility requirements, election and termination issues, restructuring and consolidated return issues.

The proposed regulation contains the following taxpayer-favorable rules pertaining to QSSSs:

1. Excess loss account and deferred intercompany gains and losses are generally eliminated when a common parent makes a simultaneous S election for itself, and a QSSS...