On January 15, the U.S. Tax Court ruled in favor of the IRS in the Vainisi case, holding that the 20% TEFRA disallowance applies to Qualified Subchapter S Subsidiary (QSub) banks in the same manner as it does to C corporation banks. The result is that a Subchapter S holding company that owns a QSub bank must apply the 20% TEFRA disallowance every year in which the QSub bank has interest expense attributable to qualified tax exempt obligations (QTEOs). Recall that the Vainisi petitioners argued that Section 1363(b)(4) of the Internal Revenue Code limits the applicability of the 20% TEFRA disallowance to only the first three years after an institution’s election to be taxed under Subchapter S. Interestingly, the Court made it clear that its ruling applied only to Sub S holding companies that own QSub banks. It specifically declined to consider whether the 20% TEFRA disallowance would apply in the same manner for S corporation parent or stand-alone S corporation banks that hold QTEOs. 

On Thursday, February 12, the Vainisi petitioners filed a Motion for Reconsideration with the Court requesting that Judge Foley reconsider his decision and a Motion for Full Court Review asking the full court to hear the case. The petitioners argue in their motions that because the Court’s January 15 opinion failed to consider whether Section 1363(b)(4) would limit the applicability of the 20% TEFRA disallowance to only those first three years for S corporation parent or stand-alone S corporation banks, reconsideration of the January 15 opinion is thus necessary. In support, the Vainisi petitioners note that other relevant Subchapter S laws do not distinguish between S corporation and QSub entities. They contend, rather, that Congressional intent dictates that “the income, losses, deductions and credits of a QSub will be taxed in the same manner as those belonging to an S corporation” and therefore, because the plain meaning of Section 1363(b)(4) clearly limits the applicability of the 20% TEFRA disallowance to only the first three years after an institution’s S election, the same should be true for a QSub. 

The IRS is likely to contest both of these motions. Judge Foley has discretion as to whether to grant the motions, and there is no time limit on when the Court must make a decision on the motions. Should the Court deny these motions, the Vainisi petitioners’ may still appeal the Court’s January 15 ruling to the Seventh Circuit Court of Appeals. The other TEFRA disallowance case, Schams, et al. v. Commissioner of Revenue, remains on hold pending a final resolution of the Vainisi case.