§ 1.1361-2 Definitions relating to S corporation subsidiaries.
(a) In general. The term qualified subchapter S subsidiary (QSub) means any domestic corporation that is not an ineligible corporation (as defined in section 1361(b)(2) and the regulations thereunder), if—
(1) 100 percent of the stock of such corporation is held by an S corporation; and
(2) The S corporation properly elects to treat the subsidiary as a QSub under § 1.1361-3.
(b) Stock treated as held by S corporation. For purposes of satisfying the 100 percent stock ownership requirement in section 1361(b)(3)(B)(i) and paragraph (a)(1) of this section—
(1) Stock of a corporation is treated as held by an S corporation if the S corporation is the owner of that stock for Federal income tax purposes; and
(2) Any outstanding instruments, obligations, or arrangements of the corporation which would not be considered stock for purposes of section 1361(b)(1)(D) if the corporation were an S corporation are not treated as outstanding stock of the QSub.
(c) Straight debt safe harbor. Section 1.1361-1(l)(5)(iv) and (v) apply to an obligation of a corporation for which a QSub election is made if that obligation would satisfy the definition of straight debt in § 1.1361-1(l)(5) if issued by the S corporation.
(d) Examples. The following examples illustrate the application of this section:
Example 1.
X, an
S corporation, owns 100 percent of Y, a
corporation for which a valid QSub
election is in effect for
the taxable year. Y owns 100 percent of Z, a
corporation otherwise eligible for QSub status. X may elect to treat Z as a QSub under section 1361(b)(3)(B)(ii).
Example 2.
Assume
the same
facts as in
Example 1, except that Y is a business entity that is disregarded as an
entity separate from its
owner under
§ 301.7701-2(c)(2) of this chapter. X may elect to treat Z as a QSub.
Example 3.
Assume
the same
facts as in
Example 1, except that Y owns 50 percent of Z, and X owns
the other 50 percent. X may elect to treat Z as a QSub.
Example 4.
Assume
the same
facts as in
Example 1, except that Y is a
C corporation. Although Y is a
domestic corporation that is otherwise eligible to be a QSub, no QSub
election has been made for Y. Thus, X is not treated as holding
the stock of Z. Consequently, X may not elect to treat Z as a QSub.
Example 5.
Individuals A and B own 100 percent of
the stock of
corporation X, an
S corporation, and, except for C's
interest (described below), X owns 100 percent of
corporation Y, a
C corporation.
Individual C holds an instrument issued by Y that is considered to be equity under general principles of
tax law but would satisfy
the definition of straight debt under
§ 1.1361-1(l)(5) if Y were an
S corporation. In determining whether X owns 100 percent of Y for purposes of making
the QSub
election,
the instrument held by C is not considered outstanding
stock. In
addition, under
§ 1.1361-1(l)(5)(v),
the QSub
election is not treated as an
exchange of debt for
stock with respect to such instrument, and
§ 1.1361-1(l)(5)(iv) applies to determine
the tax treatment of
payments on
the instrument while Y's QSub
election is in effect.
