On May 21, 2013, the U.S. Court of Appeals for the Third Circuit in In re The Majestic Star Casino1 held—as a matter of first impression—that a Chapter 11 debtor's status as a pass-through entity for taxation purposes did not constitute "property" of the Chapter 11 estate. The federal appellate court reversed the Bankruptcy Court and concluded that the revocation of the Chapter 11 debtor's tax status—caused unilaterally and intentionally by the debtor's ultimate shareholder—was not a transfer of Chapter 11 estate "property." As a result, the voluntary revocation by the shareholder which inured to its economic benefit could not be reversed or undone pursuant to the applicable provisions of the Bankruptcy Code.

In reaching its decision, the Third Circuit found that the Chapter 11 estate did not hold a "property interest" in the Chapter 11 debtor's tax status as a "QSub"—which is, generally, a wholly-owned subsidiary of a parent "S Corporation" entitled to pass-through status for tax purposes—primarily because the right to elect or revoke the debtor's status as a "QSub" was held by the debtor's non-debtor parent, not the debtor. Accordingly, the Third Circuit found that because the debtor did not possess a "property interest" in its QSub status, the debtor could not avail itself of the avoidance provisions of the Bankruptcy Code, or the protections of the automatic stay, to effectively "undo" the post-petition revocation.

S Corporations and QSubs

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