Subchapter S elections provide small businesses and their owners with substantial tax benefits. These elections allow the businesses to avoid taxation at the corporate level and cause the tax liability of the company to pass through to the shareholders. When a Subchapter S entity enters bankruptcy, the company expects tax liability to continue to pass through to the shareholders, but the shareholders often want to shift the tax liability back onto the company because they do not have access to the company’s income while it is in bankruptcy. Whether Subchapter S elections are property of the company’s bankruptcy estate is a significant factor in the ability of shareholders of these entities to revoke these elections to avoid the tax liability. Until recently, courts had found that a Subchapter S election is property of the bankruptcy estate, but never addressed a situation involving qualified subsidiaries of Subchapter S Corporations. In In re Majestic Star, the Third Circuit held that these elections are not property rights and vacated the lower bankruptcy court’s order to restore the tax statuses of a subsidiary in bankruptcy and its parent corporation.
Comparing the broad application of property rights in bankruptcy used in In re Dittmar, this Note demonstrates that the Third Circuit Court of Appeals improperly limited its analysis concerning the property nature of these elections. Subchapter S elections should be property of the estate because they provide an economic benefit to the company that can satisfy claims of creditors. The inequities and negative implications that resulted from the lower bankruptcy court’s order are also not as significant as the Third Circuit would make them seem. Some of these negative consequences could have been remedied by fixing an error in the order.
C. C. Cullum,
A Majestic Vacation: The Third Circuit Takes a Break from the Modern Trend of Including Subchapter S Elections in the Property of a Bankruptcy Estate,
Tex. A&M L. Rev.
Available at: https://scholarship.law.tamu.edu/lawreview/vol2/iss2/6