A qualified subsidiary is one that would be eligible to be an S corporation if the stock of the corporation were held directly by the shareholders of its parent S corporation. The subsidiary is generally not treated as a separate corporation for tax purposes. The ability to set up separate corporations can be helpful when doing business in different states or to keep the businesses separate for legal or other purposes. For example, local law might require that the same entity can't hold both a license to sell liquor at a package store and a bar. Using two separate corporations may allow you to avoid the restrictions.
Separate corporations can also be invaluable if the business has to be split at a later date.
The provision applies to taxable years beginning after December 31, 1996. S Corporations Treatment Under the Act, an S corporation, in its capacity as a shareholder of another corporation, is no longer treated as an individual. Thus, the provision makes it clear that the liquidation of a C corporation into an S corporation will be governed by the rules for regular corporations, including the provisions of sections 332 and 337 allowing the tax-free liquidation of a corporation into its parent. An S corporation also will be eligible to make a section 338 election. This change allows for greater flexibility in making acquisitions.