Daily Tax Update - May 22, 2013: Third Circuit Holds That QSUB Status is Not Property

Third Circuit Holds That QSub Status is Not Property:  The Third Circuit Court of Appeals has held that qualified subchapter S subsidiary (QSub) status is not property within the meaning of the Code.  The court also provided that S corporation status did not constitute property.  The case, upending several lower court cases on the subject, provides further support for certain tax planning opportunities available for owners of S corporations facing financial distress. 

  • In Re:Majestic Star Casino LLC v. Barden Development, Inc., Majestic Star Casino II, LLC (MSC II) was a wholly owned indirect subsidiary of Barden Development, Inc. (BDI) an S corporation.  BDI had elected to treat MSC II as a QSub.  Subsequent to the QSub election, MSC II, along with other debtor subsidiaries, filed a petition for bankruptcy protection.  BDI and its sole shareholder, however, did not join in the petition.  After the petition was filed, the sole shareholder of BDI revoked BDI’s S corporation election.  As a result, MSC II’s QSub status was automatically terminated.  BDI and MSC II therefore became C corporations.  Accordingly, tax on COD income arising from the bankruptcy workout would become a liability effectively borne by the creditors of BDI and its subsidiaries.
  • The Bankruptcy Court had held that MSC II had a property interest in its status as a QSub, such that when BDI revoked its S corporation status, thereby terminating MSC II’s QSub status, such revocation and resulting termination constituted an unauthorized transfer of estate property under section 549 of the Bankruptcy Code and a violation of the automatic stay imposed by section 362 of the Bankruptcy Code.  Under this holding, tax on COD income arising from the bankruptcy workout would remain a liability of the sole shareholder of BDI.
  • In a case of first impression in the federal Courts of Appeals, the Third Circuit reversed, holding that MSC II’s QSub status was not property.  In doing so, it also rejected the Trans-Lines West line of cases that held that S corporation status was property.

Director, IRS Exempt Organizations Division Pleads Fifth:  Today, in an appearance before the House Oversight Committee, Lois Lerner, the Director of the IRS Exempt Organizations Division, invoked her Fifth Amendment rights against self-incrimination and declined to testify.   In a statement at the hearing, Lerner said, "I have not done anything wrong.  I have not broken any laws.  I have not violated any IRS rules or regulations, and I have not provided false information."  Lerner added, “I know that some people will assume that I have done something wrong.  I have not."

Testimony from the hearing can be accessed here.

IRS RELEASES REVISED DRAFT FORM FOR ENTITIES CERTIFYING UNDER FATCA:  Today, the IRS released the revised draft form of the Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities) (Form W-8BEN-E) that will be used for reporting under the Foreign Account Tax Compliance Act.

The revised draft Form W-8BEN-E is available via: http://www.irs.gov/pub/irs-dft/fw8bene--dft.pdf