QSubs Recognized as Separate Entities for Employment and Excise Taxes

Editor: Kevin F. Reilly, J.D., CPA

The IRS has issued final regulations that treat qualified subchapter S subsidiaries (QSubs) and other disregarded entities (DEs) as separate entities for federal employment tax and certain excise tax purposes (TD 9356). Although the regulations are effective as of August 16, 2007, the employment tax provisions apply to wages paid on or after January 1, 2009, and the excise tax provisions apply to periods beginning on or after January 1, 2008.

Notice 99-6 may still be used by taxpayers for wages paid prior to January 1, 2009. This will give taxpayers the time necessary to modify their systems to comply with the final regulations. Beginning for wages paid on or after January 1, 2009, these rules eliminate the options afforded taxpayers under Notice 99-6. Previously, a taxpayer was allowed to calculate, report, and pay all the DE’s employment tax obligations either under the owner’s name and taxpayer identification number (TIN) or under the DE’s name and TIN.

The final regulations clarify that a DE is treated as a separate entity and as a corporation for purposes of the federal employment tax, although it continues to be disregarded for other federal tax purposes. The owner of a DE treated as a sole proprietorship is subject to self-employment taxes under the Self-Employment Contributions Act and continues to be treated as self-employed, not as an employee of the DE.

Practitioners commenting on the proposed regulations suggested that the regulations would increase the administrative burden for taxpayers, predicting that complications could arise in states where state employment tax filings are required at the owner level. The IRS and Treasury stated in the preamble to the regulations that they believe separate entity reporting will improve administration of the federal tax laws and simplify federal tax compliance. They also noted that most states adopt the separate entity concept for employment tax purposes; thus, federal and state reporting would be more closely aligned.

The regulations also affect certain excise taxes reported on Forms 720, Quarterly Federal Excise Tax Return, 730, Monthly Tax Return for Wagers, 2290, Heavy Highway Vehicle Use Tax Return, and 11-C, Occupational Tax and Registration Return for Wagering; excise tax refunds or payments claimed on Form 8849, Claim for Refund of Excise Tax; and excise tax registrations on Form 637, Application for Registration (For Certain Excise Tax Activities). For these excise taxes, the DE, in its own name and TIN, is required to pay and report excise taxes and to register with the IRS, and it is allowed to claim any credits (other than income tax credits), refunds, and payments.

Since a DE does not file an income tax return, the Sec. 34 credit for certain uses of gasoline and special fuels is claimed on the owner’s income tax re-turn. Appropriate disclosure of the DE’s name and TIN on the return is required.

The rules for excise taxes are effective January 1, 2008. For periods before this date, the owner of a DE will be treated as having satisfied the owner’s obligations with respect to the excise taxes, provided that those obligations are satisfied either by the owner or by the DE on behalf of the owner.

These regulations clarify the reporting requirements of QSubs and other DEs. In enacting them, the IRS has made an effort to improve administration by simplifying tax compliance and aligning federal employment tax treatment with most of the states. It has also considered the transitional needs of taxpayers by extending the application dates.