S-Corp and QSub Tax Status Do Not Constitute Property of the Bankrup...

In In re Majestic Star Casino, LLC, the Court of Appeals for the Third Circuit 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 bankruptcy estate.[1] The debtors, Majestic Star Casino II (“MSC II”) and other subsidiaries and affiliates, were wholly owned by a non-debtor corporation called Barden Development, Inc. (“BDI”).[2]  Don H. Barden (“Barden”) was the sole shareholder, CEO, and president of BDI.[3]  In November of 2009, the debtors filed for bankruptcy under chapter 11 of the Bankruptcy Code.[4]  Later that year, Barden chose to revoke BDI’s status as an “S” corporation (“S-Corp”) for tax purposes, thus forfeiting the company’s pass-through tax status.[5]  As a result of that election, MSC II’s status as a qualified subchapter S subsidiary (“QSub”) was also automatically revoked.[6]  Thus, MSC II was now subject to federal and state taxes that it used to pass on to Barden.[7]  MSC II asserted that the revocation of BDI’s S-Corp status constituted an unlawful postpetition transfer of property of MSC II’s bankruptcy estate.[8]  The Third Circuit reversed the decision of the bankruptcy court, holding that MSC II’s status as a QSub for tax purposes was not property, and even if it was, it would belong to the shareholders of its non-debtor parent corporation and not to MSC II.[9]