Small Business Tax Solutions
This is a series based on questions from the AICPA tax certificate of educational achievement (CEA) courses. Q. What recent legislative developments in the Congress and changes at the Internal Revenue Service have allowed S corporations to diversify their means of holding investments in subsidiary businesses? A. There are several ways in which S corporations can hold investments in other businesses. The possibilities have broadened largely as a result of passage of the Small Business Job Protection Act of 1996 and some significant changes in its positions by the IRS. SMALL BUSINESS JOB PROTECTION ACT Before 1997, S corporations were not permitted to own 80% or more of the stock in another corporation. An S corporation could own less than 80% of the stock of a subsidiary corporation, but the subsidiary could not be an S corporation. The Small Business Job Protection Act repealed Internal Revenue Code section 1361(b)(2)(A), which prohibited S corporations from being members of an affiliated group of corporations. The 1996 act also includes a provision that allows an S corporation to own a so-called qualified subchapter S subsidiary (QSSS). A QSSS is a separate corporation from the parent company under local law and thus offers the tax advantages of splitting assets for liability purposes and regulatory compliance. For federal tax purposes, however, a QSSS is disregarded as a separate entity. CHANGES AT THE IRS In 1994, the IRS reversed a 1977 ruling (revenue ruling 77-220, 1977-1 CB 263) that said an S corporation with an interest in a partnership could lose its S corporation status unless there was a valid nontax business purpose for the arrangement. This change (revenue ruling 94-43, 1994-2 CB 308) means S corporations are now free to be partners in partnerships. In the early 1990s, the IRS issued several revenue rulings on the tax status of limited liability companies (LLCs). In states that permitted LLCs to choose attributes normally found in corporations, problems arose about how certain entities were classified. The combination of LLC classification problems and the affiliated group prohibition discussed above could be deadly for an S corporation. In one situation, an S corporation owned more than 80% o1 an LLC. The IRS classified the LLC as an association. Thus, the parent company was a member of an affiliated group and lost its eligibility for S status (private letter ruling 9433008). Adoption of final regulations--Treasury regulations section 301.7701-3, known as the check-the-box regulation eliminated the uncertainty about LLC classification. …