By Leonardis, Peter C.
The CPA Journal , Vol. 70, No. 2
In 1996 Congress enacted the Small Business Job Protection Act, which included provisions that allow subchapter S corporations to have wholly owned S corporation subsidiaries, referred to as qualified subchapter S subsidiaries (QSSSs) [IRC section 1361(b)(3)(B)].
The creation of QSSSs is significant in that, upon election by an S corporation parent, a QSSS is not treated as a separate corporation for Federal income tax purposes [IRC section 1361(b)(3XA)(i)]. Furthermore, all assets; liabilities; items of income, deduction, and credit; and the tax history of a QSSS are treated as belonging to the S corporation parent. The shareholders of the S corporation parent have the ability to isolate its activities into separate entities for the purpose of limiting liability without compromising the flow-through benefits provided by S corporation status.
As is often the case with IRC changes that, at first glance, appear simple at the Federal income tax level, the QSSS provisions create a myriad of complications at the state and local tax level.
New York State
Corporate Franchise Tax
Federal S corporations are permitted to elect S corporation status for New York State tax purposes [N.Y. Tax law sections 208(1-A) and 6601. The election is made by filing New York State Form CT-6, Election by a Federal S Corporation to Be Treated as a New York S Corporation. However, New York S corporations are not afforded the total exemption from tax that applies at the Federal level. New York S corporations are subject to tax at a reduced rate equal to the difference between the regular corporate rate under Article 9-A and the equivalent rate under Article 22 for personal income tax [N.Y. Tax law section 2 10(g)(1)]. The equivalent rate is currently being reduced on a sliding scale: for tax years beginning before July 1, 1999, 1.125%; for tax years beginning after June 30, 1999, and before July 1, 2000, .975%; for tax years beginning after June 30, 2000, and before July 1, 2001, .825%; and for tax years beginning after June 30, 2001, .65% [TSPM98(7)C (Nov. 23, 1998)1. Federal S corporations that do not elect to be treated as S corporations for New York State tax purposes will be treated as C corporations.
In 1997, New York State amended its tax law to generally conform to the Federal treatment of QSSSs, adopting the definition of QSSS as provided in IRC section 1361 [N.Y. Tax Law section 208(1B)I. Unlike Federal S corporations, however, QSSSs are not required to make an election to be treated as an S corporation.
Differences in State and Federal
Income Taxation Create Complexity
In the most basic case, where the S corporation parent has elected New York S corporation status, the S corporation parent and the QSSS will be taxed as a single New York S corporation. This treatment will be followed whether or not the QSSS, on a separate basis, is a New York taxpayer [N.Y. Tax Law section 208(9)(k)(1);TSB-M-97(6)C (Sept. 9, 1997)]. Similar to the Federal treatment, the "assets, liabilities, income and deductions of the QSSS" will be deemed to be those of the New York S corporation parent. In addition, the "property, payroll, receipts, capital, credits, and all other tax attributes and elements of economic activity" will be deemed to be those of the S corporation parent [N.Y. Tax Law section 208(1-B)(a)]. Accordingly, for purposes of determining the New York State business allocation percentage, the properry, payroll, and receipts of the QSSS will flow tip into its S corporation parent.
Where the S corporation parent does not make the election for New York S corporation status, depending on whether the QSSS is a New York taxpayer, New York may follow Federal QSSS treatment. If the QSSS is a New York taxpayer, the S corporation parent and the QSSS will be taxed as a single New York C corporation. If the QSSS is not a New York taxpayer, the S corporation parent will be taxed separately and apart from the QSSS as a C corporation. …