A
C corporation is not eligible to hold stock in a Subchapter S corporation. However,
a Subchapter S corporation can own up to 100% of the stock of a C corporation.
Tax law
prevents a Subchapter S corporation from filing a consolidated return with an
affiliated C corporation. The C corporation may, however, still file a
consolidated return with its affiliated C corporations.
Qualified Subchapter S Corporation Subsidiary
(QSSS): A Subchapter S corporation can elect to treat a wholly owned subsidiary
as part of the Subchapter S corporation for tax purposes. Therefore, the subsidiary
is disregarded for tax purposes. The subsidiary does not need to be a
Subchapter S
corporation, but it must be a corporation that would qualify as a
Subchapter S
corporation if its stock was held by the shareholders of the parent
Subchapter S
corporation.
Qualification requirements for QSSS status:
1) The parent Subchapter S corporation must own 100%
of the subsidiary.
2) The parent Subchapter S corporation must make an election to treat the subsidiary
as a QSSS.
3) The subsidiary must be a domestic
corporation.
Tax
Effects of Election:
—Existing Corporation: If
an election is made to treat an existing corporation as a QSSS, the transaction is
treated as a liquidation of the subsidiary under IRC §332 and §337.
—New Corporation: If
a QSSS election is in effect when the subsidiary is formed, liquidation is not
considered to have occurred. The QSSS is disregarded for tax purposes.
Making Election: See IRS Notice
97-4 and Proposed Regulations Caution:
Not all states recognize a QSSS election.
Some states treat the QSSS as a separate entity for state tax
purposes.
Eligible Trusts
1) Grantor trusts owned by a U.S. citizen
or resident. The trust can continue for 60 days after the death of the
grantor, or two years if trust assets are includable in the
grantor’s gross estate.
2) A trust created primarily to exercise
voting power of stock transferred to it. Each beneficiary of the trust is
treated as a shareholder.
3) A trust that stock is transferred to
under terms of a will, but only for 60 days, beginning with the day the stock
was transferred to the trust. The decedent’s estate is treated
as the shareholder.
4) "Qualified Subchapter S
Trusts": May only have one income beneficiary. All accounting income must be
distributed each year. Principal
distributed during the life of the beneficiary must be distributed
to the beneficiary.
5) "Electing Small Business
Trusts" (ESBT).
An ESBT must meet the following
requirements:
• May not have a beneficiary other than
an individual or an estate that is eligible to be a Subchapter S corporation
shareholder. Exception:
Certain charitable organizations may hold a
contingent remainder interest.
• Interest in the trust must be acquired
by gift, inheritance, or other nonpurchase
acquisition. The interest may not be acquired by
purchase.
• Trust must file an election to qualify
as an ESBT. See IRS Notice 97-12 for making the
election.
Note: See
IRS Notice 97-49 for more information about ESBTs.
Domestic Corporations Ineligible For
Subchapter S Corporation Status
Types of domestic corporations ineligible for Subchapter S Corporation status are:
• DISC or former DISC—Domestic
International Sales Corporation.
• Corporation that takes the Puerto Rico
and possessions tax credit for doing business in a U.S. possession.
• Insurance company taxed under
Subchapter L of the Internal Revenue Code.
Caution: Actions
by one shareholder can terminate Subchapter S corporation status.
One Class Of Stock
A Subchapter S corporation can have only one class of
stock. The Subchapter S corporation is treated as having only one class of
stock if all outstanding shares of the corporation possess identical rights
to distribution and liquidation proceeds. Differences in voting rights are
allowed as long as the other requirements are met.
Caution: If
not properly structured, a shareholder loan to a Subchapter S corporation can create a second class of
stock and disqualify Subchapter S corporation status. If the debt is convertible to
equity, or if terms of the loan are contingent on profits or dependent on the
borrower’s discretion, the loan may be considered a purchase of a
second class of stock.
Counting Subchapter S Corporation Shareholders
For purposes of the Subchapter S
Corporation 75 shareholder limit,
the following apply:
• A husband and wife, and their estates,
are counted as one shareholder, even if they own Subchapter S corporation stock
separately.
• If Subchapter S corporation stock is owned jointly by
individuals who are not husband and wife, count each individual separately.
• If Subchapter S corporation stock is held by a trust, count the
beneficiaries as shareholders, not the trust itself as a shareholder.
