Category: International; Corporations
Subject: S Corporation
Title: S Corporation Foreign Subsidiary Issues
IRC Sections: 1361(b)
Filename: 1378.html
Date Produced: 05/98

Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com

Background
Taxpayer is an S corporation with a 99%-owned Mexican subsidiary.

Issues
Does ownership of a foreign subsidiary invalidate the taxpayer's S election?

Answers
No, for tax years beginning after 1996, ownership of an 80%-or-more subsidiary, whether domestic or foreign, does not invalidate an S election. However, the taxpayer cannot make the Qualified Subchapter S Subsidiary election with respect to a foreign subsidiary.

Discussion
For tax years beginning before 1997, an valid S corporation could not own 80%-or-more of an active subsidiary. IRC §1361(b)(2)(A), prior to amendment by Pub L No 104-188. This was referred to as the affiliated group rule. It made no difference whether the subsidiary was domestic or foreign; an active subsidiary owned 80% or more either disqualified a corporation from making an S election or terminated an existing election.

In 1996, this restriction was completely removed effective for years beginning after 1996. Section 1388 of P.L. 104-188. Based on the absence of this former restriction, an S corporation can have an 80%-or-more interest in an active subsidiary, whether domestic or foreign. However, without a Qualified Subchapter S Subsidiary election (discussed below), a subsidiary of an S corporation must be a C corporation.

At the same time the affiliated group rule was removed, it also became possible for an S corporation to elect to ignore the separate legal existence of certain qualified subsidiaries. In essence all the activities of such subsidiaries would be attributed to the parent for tax purposes, thus effectively allowing both the parent and the subsidiary to enjoy S corporation status. Only wholly-owned, domestic subsidiaries are eligible for the so-called Qualified Subchapter S Subsidiary election. IRC Section 13631(b)(3).

Accordingly, while it is possible to have a foreign subsidiary without invalidating S corporation status, the taxpayer would be unable to make the Qualified Subchapter S Subsidiary election with respect to that subsidiary.