Tackling Taxes

Section 1361(b)(3)(C) governs the income tax characterization of the termination of a qualified subchapter S subsidiary (QSub) election. The general rule is that if a QSub election is terminated, the subsidiary is treated as a new corporation acquiring all of its assets (and assuming all of its liabilities) immediately before the termination from the parent S corporation in exchange for stock of the new corporation. The application of the step-transaction doctrine can result in undesirable income tax consequences arising from a QSub termination. Further, the application of the Internal Revenue Code and general principles of tax law to a QSub termination may also result in undesirable tax consequences. The following types of transactions are examined: 1. exchange of QSub stock for partnership interests in a partnership, 2. transfer of QSub stock to a C corporation, 3. exchange of QSub stock pursuant to reorganization, and 4. election termination of a QSub that has a 50% or more owned (by vote or value) corporation.