Selling a QSub: What Happens When You Sell Part of Your Subsidiary?

As your business grows, acquires, or restructures, it’s common to revisit ownership structures—especially if you’ve formed Qualified Subchapter S Subsidiaries (QSubs) as part of your tax strategy. But if you’re thinking of selling part of your QSub to a third party, even a minority interest, it’s important to understand the federal tax consequences.
Let’s break down what happens when you sell part of a QSub—and how it could trigger a taxable event that surprises many business owners and executives.

What Is a QSub?

A QSub is a domestic corporation that is 100% owned by an S corporation and for which a QSub election has been made under IRC §1361(b)(3)(B). It’s essentially disregarded for federal tax purposes, meaning its assets, liabilities, and income are treated as if they belong directly to the parent S corp.

This structure offers simplicity, tax consolidation, and operational flexibility—but it only works if the ownership remains 100% with the parent S corporation.

What Happens If You Sell Part of a QSub?

If the parent S corporation sells any portion of its QSub stock—even just 1%—the QSub election automatically terminates under federal tax rules (Treas. Reg. §1.1361-5(a)(1)(iii)).

Deemed Liquidation Before the Sale

Before the termination takes effect, the QSub is treated as having liquidated into the parent S corporation at the end of the day prior to the sale (Treas. Reg. §1.1361-4(a)(2)). This means that for federal income tax purposes, the S corp now directly owns all the QSub’s underlying assets.

So when you sell 50% of the QSub stock, the IRS sees it as if you’ve sold 50% of the assets of the business—not just stock.
Taxable Event Triggered

Because the QSub is disregarded and deemed liquidated, the sale of ownership becomes a taxable sale of business assets under IRC §1001.
This can result in:

• Recognized capital or ordinary gain/loss depending on the asset types (e.g., real estate, goodwill, receivables)
• Flow-through tax impact to the S corporation shareholders
• Potential depreciation recapture or other tax attributes that must be handled carefully

If your QSub holds appreciated assets, this sale can produce a significant tax liability—often unexpectedly if not properly planned.

Can the QSub Be an S Corporation Again?

After the QSub election is terminated, the now stand-alone corporation does not automatically regain S status. It must file a new S election (Form 2553) to continue being treated as an S corporation.

However, there’s a catch:

If the QSub was previously an S corporation before becoming a QSub, and no timely S election is made upon termination, it may be barred from making another S election for 5 years under IRC §1361(b)(3)(D).

The only way around this is to:

1. File a timely S election (effective immediately after the QSub termination), or
2. Request IRS relief for late election under Rev. Proc. 2013-30

Key Takeaways for Growing Businesses

• Selling even part of a QSub terminates its status and triggers a deemed liquidation.
• The parent S corporation is treated as selling assets, not stock—resulting in a taxable event.
• Plan proactively to manage the tax consequences and consider timing of new S elections carefully.
• This is especially relevant during growth, succession planning, equity raises, or partial exits.

Who Should Pay Attention?

This topic is especially relevant to:

• Business owners and founders preparing for investment or partial sale
• CFOs and controllers managing entity structure and tax impact
• CEOs evaluating M&A activity or divesting business lines
• Private equity portfolio companies transitioning QSubs post-acquisition

Need Guidance?

At Cambaliza McGee, we work with closely held businesses navigating complex ownership structures, reorganizations, and tax-sensitive transactions. If you're considering a change in QSub ownership or need help evaluating the tax consequences of a partial sale, contact us.