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For want of a QSUB, the shelter was lost

October 11, 2011

Presidio Advisors, LLC, a boutique firm at the center of the tax shelter industry of the late 1990s, got another spot on its record last week in the Court of Federal Claims. This time, the losers weren't outside tax shelter investors, but Presidio's founders.

Presidio put together a basis-shifting shelter that involved transferring assets to "qualified subchapter S subsidiary," or QSUB. If an S corporation owns 100% of the stock of another corporation, the subsidiary's activities are included on the S corporation return if the subsidiary makes a "QSUB" election.

Presidio set up a shelter deal where it set up a corporation, PCC, to buy equiment from a foreign corporation for consideration for $11.7 million, including an obligation to close a $12 million short sale on treasury securities. The equipment had a built-in loss of around $11.4 million, based on this value. The organizers contributed the PCC stock to an S corporation called Prevad, owned largely by lead figures in Presidio. PCC was intended to be a QSUB of Prevad.

PCC then contributed the property to Presido Advisors, LLC, which then sold the property for a big loss, which passed through the LLC K-1 to the QSUB and thence to the Prevad S corporation return.

Except for one little problem. The court explains:

In this case, petitioners contend that PCC was a QSub of Prevad, entitling Prevad to treat PCC's assets as its own, as of the effective date of the election. They further assert that Prevad assumed PCC's $11,881,813 basis in the latter's equipment before that equipment was contributed to Presidio on November 8, 1998. The latter must be true if Presidio has any hope to deduct the $10,644,471 loss it claims on Presidio's subsequent sale of the equipment. In its motion for partial summary judgment, however, respondent argues that Prevad's election to treat PCC as a QSub was not effective as of November 8, 1998, such that PCC's allegedly stepped-up basis in its equipment did not carry over to Presidio. It would appear that respondent is right.

Did somebody fail to file a QSUB election? No; it looks more like the shelter organizers were careless in throwing their entities around:

Rather, petitioners admit that Prevad did not become the sole shareholder of PCC until November 6, 1998. Petitioners, moreover, further admit that Prevad did not retain its ownership of PCC, but rather, on the same day, transferred its shares in PCC to Presidio. Accordingly, PCC was not held by a Subchapter S corporation for the entire retroactive period in question and thus failed to qualify as a QSub.

It's not clear the shelter would have worked if the equipment had been a QSUB on November 8, but it clearly fails once the court decides that it wasn't. Without an effective QSUB election, the loss is locked in a C corporation with no income of its own.

The Moral? Paperwork matters. If you are basing a big transaction on effective dates of incorporations and tax elections, and you are cutting it close, make very sure that your paperwork has all of the right dates.

Cite: Presidio Advisors LLC, Ct of Federal Claims No. 05-411.

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