[Code of Federal Regulations]
[Title 26, Volume 11]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.1361-2]

[Page 710-711]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 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 Sec. 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

[[Page 711]]

QSub election is made if that obligation would satisfy the definition of 
straight debt in Sec. 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 Sec. 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 Sec. 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 Sec. 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 Sec. 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.

[T.D. 8869, 65 FR 3849, Jan. 25, 2000]