QSub status is not property of bankruptcy estate.

• Author: Beavers, James A.
• Position: Subchapter S corporation subsidiary

The Third Circuit held that an S corporation's revocation of its S corporation status, which caused its QSub subsidiary to lose its status as a QSub, was not a post-bankruptcy-petition transfer of property of the QSub's bankruptcy estate.

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Background

Barden Development Inc. (BDI) was an Indiana corporation that had elected to be treated as an S corporation. Barden was owned by Don Barden (Barden). BDI was the owner of Majestic Star Casino II Inc. (MSC II), the owner and operator of a hotel and casino in Gary, Ind.

In 2009, MSG II filed a petition for bankruptcy. MSC IPs debtors became the debtors-in-possession of the bankruptcy estate. At the time the petition was filed, BDI and MSC II remained an S corporation and a QSub. However, Barden, without informing the MSC II debtors or the bankruptcy court, subsequently revoked BDFs S corporation election as of Jan. 1,2010. This caused a termination of MSC II's QSub status. Thus, both BDI and MSC II became C corporations as of Jan. 1, 2010, and, as a consequence, MSC II became responsible for filing its own tax returns and paying income taxes on its holdings and operations. This had the practical effect of transferring MSC IPs tax burden from Barden (through BDI) to the MSC II debtors.

Unsurprisingly, the MSC II debtors were not pleased with this turn of events, and they filed a complaint with the bankruptcy court against BDI, Harden, the Indiana Department of Revenue, and the IRS (the defendants), asserting that the revocation caused an unlawful post-petition transfer of MSC II's bankruptcy estate property. The complaint sought recovery of that "property" through an order directing the IRS and the Indiana Department of Revenue to restore BDI's status as an S corporation and MSG IPs status as a QSub retroactively effective to Jan. 1,2010.

The Bankruptcy Court's Decision

The Bankruptcy Court held that MSC Us status as a QSub was the property of MSC II, and that, as such, it belonged to MSC IPs bankruptcy estate. The court therefore concluded that the revocation by nondebtor BDI of its status as an S corporation, and the resulting termination of MSC IPs status as a QSub, were void and of no effect. Finally, the court ordered the defendants, including the IRS, to take all actions necessary to restore the status of MSC II as a QSub of BDI.

The bankruptcy court found that QSub status is analogous to S corporation status and, based on In re Trans-Lines West, Inc., 203 B.R. 653...