Third Circuit - Qsub election did not create “item of income” requiring bases adjustments 

February 12:  The U.S. Court of Appeals for the Third Circuit today affirmed an opinion of the Tax Court, finding that a S corporation’s election to treat its subsidiary as a qualified subchapter S subsidiary (Qsub), followed by the subsequent sale of the parent S corporation, did not create an “item of income” under section 1366(a)(1)(A) that in turn required the taxpayers holding stock in the parent S corporation to adjust their bases in stock under section 1367(a)(1)(A). R Ball v. Commissioner, No. 13-2247 (3d Cir. February 12, 2014)

The issue was whether the taxpayers properly increased their adjusted bases in shares of an S corporation pursuant to sections 1366 and 1367 after the S corporation made the Qsub election, which resulted in a deemed section 332 liquidation of a subsidiary. The Tax Court concluded that the unrecognized gain resulting from the Qsub election did not create an item of income or tax-exempt income under section 1366(a)(1)(A), and that the taxpayers improperly adjusted their bases in the stock following the Qsub election pursuant to section 1367(a)(1)(A).

The Third Circuit today affirmed and concluded that the claimed increases in stock bases and declared losses were improper.

Read the Third Circuit’s decision [PDF 186 KB]

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