Chapter 6B. Corporate Liquidations Howard Godfrey, Ph.D., CPA Professor of Accounting Edited...

Chapter 6B.Corporate

LiquidationsHoward Godfrey, Ph.D., CPA

Professor of Accounting Edited February 3, 2010

Copyright Howard Godfrey, 2010

The student should be able to:

1. Understand the difference between a complete liquidation and dissolution.

2. Apply general shareholder gain and loss recognition rules for a corporate liquidation.

3. Determine when the liquidating corporation recognizes gains and losses on a liquidating distribution.

The student should be able to:

4. Determine when the § 332 and § 337 nonrecognition rules apply to the liquidation of a subsidiary corporation.

5. Determine the effect of a liquidation on liquidating corporation's tax attributes.

6. Understand different tax treatments for open & closed liquidation transactions.

7. Determine when a liquidating corp. recognizes gains and losses on retirement of debt.

Remember: Under § 351, usually no tax cost is involved in forming a corporation.

The tax costs of liquidating a corporation may be substantial.

Note on the next slide that four ways are shown for Big to acquire Local Corp. (plus 2 more ways with debt).

Some may involve liquidating Local.

Cash $500 Cash $100Other Assets 400 Other Assets 300Total $900 Total $400Debt $400 Debt $100Com. Stock 200 Com. Stock 100Ret. Earn. 300 Ret. Earn. 200Total $900 Total $400

Ways to Acquire Local Corporation

Big Corporation Local Corporation

Big Stockholders Local Stockholders

Ways to Acquire Local – Cont’d

Please explain the process involved in each of the types of acquisitions illustrated on the preceding slide.

Which ones may likely involve liquidating Local Corporation?

Overview of a Corporate Liquidation. A. The Shareholder. When a corporation is liquidated, the liquidating distribution is treated as an amount received in exchange for the shareholder's stock.

Gain or loss is recognized to the extent that money and FMV of property received exceeds the adjusted basis of the stock surrendered.

Basis of property received is its FMV on the liquidation date.

Long-term capital gains of individuals are taxed at a maximum 15% rate as are qualified dividends (temporarily).

The Corporation.

Liquidating corp. recognizes gain or loss on distribution of property to shareholders. § 336

Gain or loss is the amount of gain or loss that would have been recognized if the property were sold to the distributee.

Tax attributes of the corporation disappear on liquidation. The tax attributes of a controlled subsidiary generally carry over to its parent corporation.

Understand the difference between a complete liquidation and dissolution.

Definition of a Complete Liquidation.

The term "complete liquidation" as defined in Reg. § 1.332-2(c) indicates that distributions made by a liquidating corp. must either completely cancel or redeem all of its stock in accordance with a plan of liquidation or be one of a series of distributions that completely cancels or redeems all of its stock.

A distribution that is made before a plan of liquidation is adopted will generally be taxed under the dividend distribution or stock redemption rules.

Definition of a Complete Liquidation.

A liquidation status exists when the corporation ceases to be a going concern and its activities are merely for the purpose of winding up its affairs, paying its debts, and distributing any remaining properties to its shareholders. The retention of a nominal amount of assets does not prevent liquidation from occurring under the tax rules.

Definition of a Complete Liquidation. The liquidation of a corp. does not mean that the corporation has undergone dissolution. Dissolution is a legal term that implies that the corporation has surrendered the charter it received from the state. A corp. may complete its liquidation before surrendering its charter to the state and undergoing dissolution. Dissolution may never occur if the corp. retains its charter in order to protect the corporate name from being acquired by another party.

Temporary Detour to Illustrate Importance of the liquidation concept-1

A charlotte woman died in 2009 owning an S corp., with mostly worn-out and fully depreciated equipment. It also had a good customer base. Its basis in assets was very small, so lets just say the assets had basis of zero.

What does §1371(a) say about the applicability of Subchapter C to S corps?


Husband inherited the stock of the S corp, thinking it was not worth very much. However, a multinational corporation wanted a foothold in Charlotte.

On January 1, 2010, the multinational paid $1,000,000 for the assets (mainly customer list and good business name) of the corp. Presumably, this means the FMV of S corp stock was $1,000,000 at death. See §1014.


What is husband’s basis in the stock inherited from his wife in 2005? See §1014.

What is impact on husband on January 1, 2010 when the S corp. sells its assets (basis of zero) for a selling price of $1,000,000? § 1363(a), §1366(a),(b).

What is the effect of the sale on the basis of the S corp. stock inherited by husband? § 1367

Temporary Detour to Illustrate Importance of liquidation concept-4

What happens when the husband liquidates the S corporation and receives $1,000,000 as a liquidating distribution?§ 331, § 1211.


The surviving husband wants to keep the S corporation in existence for a couple of years to take advantage of the corporate health insurance, etc. The S corporation would keep the $1,000,000 in savings until the corporation is liquidated.

Do you recommend that? § 1211, 1212

What about PHC, or Passive Income Tax?

Temporary Detour to Illustrate Importance of liquidation concept-6

Is it important to liquidate the S corporation in 2011?

What happens if the S corporation keeps its $1,000,000 until 2012 -- and is liquidated in 2012?

Apply general shareholder gain and loss recognition rules for a corporate liquidation.

L Corp. adopted a plan of liquidation on Jan. 31. L sold its property, paid its income taxes and distributed cash of $900,000 to its only stockholder in complete liquidation. E & P before distribution were $600,000. Stockholder’s adjusted basis in L Corp. stock was $700,000.

Tax effects of the liquidation to stockholder? [Sec. 331(a)]

Dividend income? ____________

Capital gain of? ____________

L Corp. adopted liquidation plan on Jan. 31. L sold its property, paid its income taxes and distributed cash of $900,000 to its only stockholder in complete liquidation.

E & P before the distribution were $600,000.

Stockholder’s adjusted basis in L Corp. stock was $700,000.

Tax effects of the liquidation to stockholder? [Sec. 331(a)] [Pg. 5] Dividend income? 0Capital gain of? $200,000E&P not relevant for liquidation.

Sue owns all of the stock in Big Corp. Sue has a basis of $5,000 in the stock. Big adopts a plan of liquidation, pays all tax liabilities for the year, and distributes two assets to Sue: (1) Cash of $10,000 and (2) Land: Basis of $30,000 &

FMV of $70,000. Income or gain recognized by Sue? [Sec. 331(a), 1001] Dividend income? ____________Capital gain of? ____________

Sue owns all of the stock in Big Corp. Sue has a basis of $5,000 in the stock. Big adopts a plan of liquidation, pays all tax liabilities for the year, and distributes two assets to Sue: (1) Cash of $10,000 and (2) Land: Basis of $30,000 &

FMV of $70,000. Income or gain recognized by Sue? [Sec. 331(a), 1001] Dividend income? 0Capital gain of? $75,000

General Liquidation Rules.

The liquidation rules are presented in two parts:1. General liquidation rules, and 2. Special rules for liquidations of 80%-or-more-owned subsidiary. General liquidation rules are divided into two parts--the effects of liquidating on the shareholders, and the effects of liquidating on the corporation.

Effects of Liquidating on Shareholders.Amount of Recognized Gain or Loss. Amount received as a distribution in complete liquidation is treated as full payment for the stock or debt that is surrendered. Gain or loss is the difference between the amount realized and basis. Liabilities assumed or acquired reduce the amount realized.

Effects of Liquidating on the Shareholders.a. Impact of Accounting Method.Shareholder using the accrual method of accounting recognizes gain or loss when all events have occurred that fix the amount of the liquidating distribution and the shareholder is entitled to receive it upon surrender of his/her shares. Cash method of accounting shareholder recognizes gain or loss when they are in actual or constructive receipt of the distribution. b. When Stock Is Acquired. A shareholder must compute gain or loss separately for each share or block of stock owned.

Effects of Liquidating on Shareholders.

2. Character of the Recognized Gain or Loss. Gain or loss is generally a capital gain or loss. For some individual shareholders, the loss may be ordinary if the stock qualifies as small business corporation stock under Sec. 1244.

3. Basis of Property Received in the Liquidation. The basis of property received is its FMV on the date of distribution. The holding period starts on the day after the distribution date.

Asset Distributed - Cash $40,000Current E & P Balance $25,000Accumulated E & P Balance $10,000Shareholder's basis in stock $4,000

Div. Income Capital Gaina. $35,000 $5,000b. $35,000 $1,000c. $40,000 $0d. $0 $36,000 §331

Red Corp. distributed its only asset toits shareholder in complete liquidation:

The individual shareholder will report

Asset Distributed - Land - FMV $40,000Shareholder's basis in stock $4,000

gain of:a. $38,000b. $36,000c. $40,000d. $0

Orange Corp. distributed its only asset toits shareholder in complete liquidation:


Asset Distributed - Land - FMV $40,000Debt on land, which is assumed by shareholder $2,000Shareholder's basis in stock $4,000

gain of:a. $38,000 c. $40,000b. $34,000 d. $0

Orange Corp. distributed its only asset toits shareholder in complete liquidation:


Determine when the

liquidating corporation recognizes gains and losses on making a liquidating distribution.

Effects of Liquidating on Liquidating Corp.

1. Recognition of Gain or Loss When Corporation Distributes Property in Redemption of Stock.

Section 336(a) provides that gain or loss is recognized by liquidating corporation when property is distributed in a complete liquidation. The amount and character of the gain or loss are determined as if the property is sold to the distributee immediately before the distribution at its FMV.


1. Recognition of Gain or Loss When Corporation Distributes Property in Redemption of Stock.

The general (Prev. Slide) rule does not apply to partial liquidations or to the retirement of debt of a controlled subsidiary in exchange for appreciated property.


2. Liabilities Assumed or Acquired by the Shareholder.

When liabilities assumed or acquired by the shareholder exceed the property's adjusted basis, gain will be recognized at the time of the distribution in an amount equal to the greater of

(1) the liability assumed or acquired, or

(2) the FMV of the property distributed, minus the property's basis.

Effects of Liquidating on Liquidating Corp.3. Exceptions to the General Gain or Loss Recognition Rule. There are four exceptions to these rules, which are listed below.a. No gain or loss is recognized by the liquidating corporation on the distribution of property to an 80% distributee in a complete liquidation of a subsidiary corporation to which Sec. 332 applies. b. No loss is recognized when a distribution of property is made to minority shareholders in a complete liquidation of a subsidiary corporation to which Sec. 332 applies.

Effects of Liquidating on Liquidating Corp.3. Exceptions to the General Gain or Loss Recognition Rule. There are four exceptions to these rules, which are listed below.c. No loss is recognized in connection with distributions of property to a related person if the distribution is not pro rata, or the property being distributed is a disqualified property. d. Losses are limited on the sale, exchange or distribution of properties acquired by the liquidating corp in a Sec. 351 transaction, or as a contribution to capital, where the acquisition of the property by the liquidating corporation is part of a plan that has as its principal purpose the recognition of a loss by the liquidating corporation.

Basis FMV Inventory $10,000 $20,000 Land held as investment $5,000 $40,000

Black Corp. distributes these assetsto its shareholder in a complete liquidation:

Land is subject to a $30,000 liability. What are amounts & character of income

d. $10,000 ordinary income; $5,000 capital gain.

to be recognized by Black? § 331(a) a. $10,000 ordinary income; $35,000 capital gain.

b. $10,000 ordinary income; $65,000 capital gain.

c. $0 ordinary income; $0 capital gain.

Basis FMV Inventory $10,000 $20,000 Land held as investment $5,000 $40,000

d. $10,000 ordinary income; $5,000 capital gain.

to be recognized by Black? § 331(a) a. $10,000 ordinary income; $35,000 capital gain.

b. $10,000 ordinary income; $65,000 capital gain.

c. $0 ordinary income; $0 capital gain.

Black Corp. distributes these assetsto its shareholder in a complete liquidation:

Land is subject to a $30,000 liability. What are amounts & character of income

Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0

a. $30,000 gain. b. $80,000 gain.c. ($50,000) loss. d. $0 none (IRS 2003)

[§ 61, 336(a), 337(a)]Gain or loss Beck recognizes?

Mr. Con bought 100% of Beck Corp. stock in 2001.

Now, Beck is liquidated. The onlyasset (land) is distributed to Con.

Now, Beck is liquidated. The onlyasset (land) is distributed to Con. Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0




Beck had just enough cash to pay itsFed. tax on the distribution. The only


other asset (land) was distributed to Con.

How much tax is paid by Beck Corp?[§ 61, 336(a), 337(a), 11, 1201]


Beck is being liquidated.

Beck is being liquidated. The onlyasset (land) was distributed to Con. Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0


[§ 61, 1001, 331(a), 332(a), (b)]Gain or loss Con recognizes?


Beck is being liquidated. The onlyasset (land) was distributed to Con. Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0Then Con sold the land for $130,000


Con's gain on the sale? [§ 334(a), (b)]


Beck is being liquidated. The onlyasset (land) was distributed to Con. Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0Then Con sold the land for $130,000

a. $30,000 gain. b. $80,000 gain.c. ($50,000) loss. d. $0 none

Con's gain on the sale? [§ 334(a), (b)]


Determine when the

Sec. 332 and Sec. 337 nonrecognition rulesapply to the liquidation of a subsidiary.

Liquidation of Controlled Subsidiary.

The discussion of the controlled subsidiary exception is divided into three parts-

1. requirements for using the exception,

2. effects of liquidating on parent corporation,

3. effects of liquidating on subsidiary.

Liquidation of a Controlled Subsidiary.

Section 332(a) applies to the parent corporation and provides that no gain or loss is recognized when a controlled subsidiary is liquidated into its parent corporation.

Sec. 337 permits the liquidating corporation to recognize no gains or losses on the assets distributed to the parent corp.

Gains (but not losses) are recognized on distributions made to shareholders holding minority interests.

Liquidation of a Controlled Subsidiary.Requirements for a liquidation - Sec. 332: (1) Parent must own at least 80% of the total combined voting power of all classes of voting stock and 80% of the total value of all classes of stock (other than certain nonvoting preferred stock issues) from the date the plan of liquidation is adopted until receipt of the property of the subsidiary corporation.; (2) the distribution must be in complete cancellation or redemption of all of sub. stock; (3) distribution must occur within a single tax year or be one of a series of distributions that are completed within three years of the close of the tax year during which the first of the series of liquidating distributions is made.

Liquidation of a Controlled Subsidiary1. Stock Ownership. Parent must own 80% of all voting stock and 80% of the total value of all classes of stock (other than certain nonvoting preferred stock issues) from the date on which the plan of liquidation is adopted until receipt of the property of the subsidiary. Sec. 318 attribution rules do not apply when determining if the 80% minimum has been met.2. Cancellation of the Stock. The subsidiary must distribute its properties in complete cancellation or redemption of all of its stock in accordance with a plan of liquidation. All property must be distributed under the plan of liquidation. Retention of a nominal amount of properties to permit retention or sale of the corporate name is permitted.

Liquidation of a Controlled Subsidiary

3. Timing of Distributions. Distribution of all the subsidiary's assets within one tax year, in complete cancellation or redemption of all its stock, is considered a complete liquidation. Subsidiary can carry out the plan of liquidation by making a series of distributions that extend over a period of more than one tax year to cancel or redeem its stock. A formal plan of liquidation must be adopted when the liquidating distributions extend beyond a single tax year. A series of distributions must be competed within three years.

Effects of Liquidating on the Shareholders.

1. Recognition of Gain or Loss. The Sec. 332(a) nonrecognition rules apply only to a parent that receives a liquidating distribution from a solvent sub. They do not apply to a parent that receives a liquidating distribution from an insolvent sub, to minority shareholders who receive liquidating distributions, or to a parent that receives a payment to satisfy the sub's debt to the parent. Insolvent Sub. The nonrecognition provisions do not apply to a parent that receives a liquidating distribution from an insolvent sub. In such a situation, generally an ordinary loss is recognized under Sec. 165(g)(3) in the amount of the adjusted basis of the parent's stock investment.

Effects of Liquidating on the Shareholders. b. Minority Shareholders. Liquidating distributions made to minority shareholders are taxed under the Sec. 331 general liquidation rules. These rules require the minority shareholders to recognize gain or loss - which is generally capital - upon the redemption of their stock in the subsidiary corporation.2. Basis of Property Received. Basis of property received by the parent is the subsidiary’s basis. Property received by minority shareholders has a basis equal to its FMV because gain or loss is recognized by the minority shareholders upon receipt of the liquidating distribution.




Con Corporation bought 100% of Beck Corp. stock in 2001.

Beck is being liquidated. The onlyasset (land) is distributed to Con.





Beck is being liquidated. The onlyasset (land) is distributed to Con.

Beck is being liquidated. The onlyasset (land) is distributed to Con. Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0




Beck is being liquidated. The onlyasset (land) was distributed to Con. Con's cost of Beck Stock $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV $130,000 Debt on the land $0Then Con sold the land for $130,000


Con's gain on the sale? [§ 334(b)]


Beck is being liquidated. The onlyasset (land) is distributed to Con. Con's cost of Beck Stock $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV $130,000 Debt on the land $0Then Con sold the land for $130,000


Con's gain on the sale? [§ 334(b)]


Determine effect of a liquidation on the liquidating corporation's tax attributes.

Effects of Liquidating on The Subsidiary1. Recognition of Gain or Loss. No gain or loss is recognized by the liquidating corporation on the distribution of property to the 80% distributee in a complete liquidation. The depreciation recapture provisions do not override the nonrecognition rule. Liquidating distributions that are made to minority shareholders are not eligible for the protection of Sec. 337(a). The liquidating corporation must recognize gain (but not loss) when property is distributed to the minority shareholders.

Effects of Liquidating on Subsidiary

2. Tax Attribute Carryovers. Tax attributes disappear when a liquidation is complete.

They carry over, however, in the case of a controlled subsidiary corporation that is liquidated into its parent corporation under Sec. 332. Common tax attributes include NOLs and capital losses.

Later, Beck was liquidated. The onlyasset (land) was distributed to Mr. Con. Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0

What happens to the NOL?


Beck had a Net Operating Loss carryover from prior years.

Beck was liquidated. The onlyasset (land) was distributed to Con. Con's cost of Beck Stock: $100,000 Beck's Land - Tax Basis: $50,000 Beck's Land - FMV: $130,000 Debt on the land: $0

What happens to the NOL? [§ 381]


Beck had a Net Operating Loss carryover from prior years.

Understand the different tax treatments for open and closed liquidation transactions.

Special Shareholder Reporting Issues.

Partially Liquidating Distributions. When a series of partially liquidating distributions are made in complete liquidation, complete liquidation rules apply.

Shareholder's basis is first recovered and then gain is recognized once basis of a particular share or block of stock has been fully recovered. Losses are generally not recognized until final liquidating distribution is actually or constructively received.

Special Shareholder Reporting Issues.Subsequent Assessments Against the Shareholder. A shareholder may be required to pay a contingent liability of the corporation or a liability that is not anticipated at the time of the liquidating distribution. If the liquidation resulted in a capital gain being reported in the year of liquidation, then a capital loss is reported in the year the liability is paid by a cash basis shareholder, or at the time the liability is incurred by an accrual basis shareholder.

Special Shareholder Reporting Issues.Open Versus Closed Transactions. Not all properties are susceptible to valuation. Gain, but not loss, is recognized when liquidation occurs taking into account only those properties that can be valued. As properties that could not be valued are sold, collected, or able to be valued, the additional amounts received are treated as a return of capital or as gain that is reported in the same way as was any gain originally reported when the property that was able to be valued was received. The position of the IRS is that the FMV of almost any asset should be able to be determined. The IRS assumes that the open transaction method should be used only in extraordinary

Special Shareholder Reporting Issues.Installment Obligations Received by Shareholder. Normally installment obligations received by a shareholder in a distribution are reported at their FMV to determine the shareholder's recognized gain or loss on the liquidation. Shareholders who receive an installment obligation that was acquired by the liquidating corporation in connection with the sale or exchange of its property are eligible for special treatment in reporting their gain on the liquidating transaction if the sale or exchange takes place during the 12-month period beginning on the date a plan of complete liquidation is adopted and ending on the date the liquidation is completed. These shareholders may report their gain as the installment obligations are collected.

Special Corporate Reporting Issues.A. Expenses of Liquidation. The corporation is permitted to deduct on its final return the costs of liquidation. These include attorneys' fees, accountants' fees, costs incurred in drafting the plan of liquidation and obtaining shareholder approval, etc. The cost of selling assets reduces the sales proceeds from the assets sale. This reduces the amount of gain or loss recognized by the liquidating corporation. B. Treatment of Net Operating Losses. An NOL created in the final year of a corp's existence may be carried back to offset taxes paid in prior years. If the loss is not used prior to the corp's liquidation, it is lost. See, however, the tax attribute carryover rules below that permit subsidiary NOLs to be acquired by parent.

Determine when a

liquidating corporation recognizes gains and losses on retirement of debt.

Gain or Loss-Property Distributed In Retirement of Debt. General Rule. No gain or loss is recognized when unsecured debt owed by the liquidating corp. to a shareholder is paid. An exception is made when a security is retired and the amount received by the shareholder is different from the shareholder's adjusted basis for the obligation. Shareholder will recognize gain or loss in this case. These same rules apply whether the debt is paid or retired as part of a debtor corp's operations or as part of its liquidation. Debtor corporation recognizes gain or loss when it uses cash to satisfy its debt obligations. Gain is recognized when appreciated noncash property is used by a debtor corporation to satisfy its debt obligations. Similarly, a loss is recognized when noncash property that has declined in value is used by a debtor corporation to satisfy its debt obligations.

Recognition of Gain or Loss When Property Is Distributed In Retirement Of Debt. Satisfaction of the Subsidiary's Debt.

The Sec. 332(a) nonrecognition rules apply only to amounts received by the parent in its role as a shareholder.

Parent does recognize gain or loss upon receipt of property in payment of a subsidiary corporation indebtedness.

Tax Planning Considerations.Timing of Liquidations. Liquidating distributions often are made over two tax years. Selling or distributing loss property while the corporation still has business income will allow these losses to be recognized and offset profits that may be taxed at higher rates. Delaying recognition of gain on appreciated property sales and distributions will defer the payment of taxes one year and possibly result in this income being taxed at lower tax rates if the corporation has discontinued operations. The tax position of individual shareholders should also be considered when making liquidating distributions.

Tax Planning Considerations.Recognition of Ordinary Losses When a Liquidation Occurs. Section 1244 is available when a complete liquidation occurs. This provision provides that $50,000 of ordinary loss can be claimed when stock is surrendered, or $100,000 if the taxpayer is married and files a join return. Ordinary loss treatment is also available for a domestic corporation that owns stock or debt securities in a subsidiary corporation. Since Sec. 332 does not apply when a subsidiary is insolvent, the parent recognizes a loss on the worthless stock and debt securities. This loss is ordinary (not a capital loss) if at least 80% of the voting stock and 80% of each class of nonvoting stock are owned by the domestic corporation and more than 90% of the liquidating corporation's gross income for all tax years has been from sources other than passive income.

Tax Planning Considerations.Obtain 80% control to Achieve Sec. 332 Benefits. A parent wishing to use the nonrecognition provisions of Sec. 332 may acquire additional shares of a subsidiary's stock in order to meet the 80% stock ownership minimum prior to the adoption of the plan of liquidation. The parent might also have the subsidiary redeem the shares of the minority shareholders in order for the parent to meet the 80% stock ownership minimum. Property distributions in liquidation of the subsidiary would be nontaxable to both corporations under Sec. 332(a). Property distributions to minority shareholders would be taxable.

Tax Planning Considerations.D. Avoiding Sec. 332 to Recognize Losses. A parent may wish to avoid the nonrecognition rules of Sec. 332 and recognize a loss when a solvent subsidiary liquidates. This can be accomplished by selling some of the subsidiary's shares to reduce the parent's stock ownership below the 80% stock ownership minimum prior to adopting the plan of liquidation. The subsidiary would also be able to recognize a loss since the nonrecognition provisions of Sec. 337 would also not be applicable.

VIII. Compliance and Procedural Considerations.A. General Liquidation Procedures. A corp must file a Form 966 [Corporate Dissolution or Liquidation] within 30 days after the adoption of any resolution or plan calling for the dissolution or liquidation of the corporation. An additional Form 966 must be filed within 30 days if there is an amendment or supplement. The form is filed with the District Director. Every corp that makes a distribution of $600 or more during a calendar year must file a Form 1099-DIV [U.S. Information Return for Recipients of Dividends and Distributions]. A separate form is filed for each shareholder.

VIII. Compliance & Procedural Considerations.B. Sec. 332 Liquidations. Every corporation receiving distributions in a complete liquidation under the Sec. 332 nonrecognition rules is required to maintain permanent records. These include a certified copy of the plan of liquidation, a list of all the properties received in distribution, a statement of any indebtedness of the liquidating corporation to the recipient corporation, and a statement of stock ownership that must be included in the corporate distributee's return for the tax year in which a liquidating distribution is received.

Compliance & Procedural Considerations.Plan of Liquidation. A plan of liquidation is a written document detailing the steps to be undertaken while carrying out liquidation. The date of adoption of a plan is the date the shareholders adopt a resolution authorizing the distribution of all of the corporation's assets in redemption of their stock. Informal agreements and resolutions have been accepted by the IRS and the Courts that may accelerate the date on which a plan of liquidation has been adopted.

Book Value FMV

Cash 600,000$ 600,000$ Receivable 100,000 100,000 Land & Bldg 500,000 1,400,000 Acc. Deprec. (100,000) Total Assets 1,100,000$ 2,100,000$ Debt on Bldg 100,000$ 100,000$ Jan's Equity 1,000,000$ 2,000,000$

Jan Co. - A Proprietorship- Case 1

• What is tax impact if Jan invests all assets and debt into a new corporation and receives 100% of stock in return?

• How do these rules compare to those for investing in partnership?

• For Jan, will the rules work in reverse if she liquidates the corp. ---and receives the assets back from the corporation?

• Do the rules work in reverse for pulling those assets back out of a partnership (assuming we have 2 or more partners)?

Book Value FMVCash 600,000$ 600,000$ Receivable 100,000 100,000 Land & Building 500,000 1,400,000 Accum. Deprec. (100,000) Total Assets 1,100,000$ 2,100,000$ Debt on Bldg (100,000)$ (100,000)$ Owner Equity 1,000,000$ 2,000,000$ Common Stock 100,000$ 2,000,000$ Add. Pd in Capital 200,000 Retained Earnings 700,000 Owner Equity 1,000,000$ 2,000,000$

Jan Corp.-Cases 1, 2, 3 and 4.

Case 1. Jan Corp. sells the land and building to Big Corp. for $1,400,000. Jan Corp collects receivable, pays debts. Jan Liquidates Jan Corp. Jan receives cash in liquidation.

Impact on Jan Corp. Sec. 1001.

Impact on Jan. Section 331.

Impact on Big Corp. 1012

Case 1.

§1001 Gain = Amount realized less basis.Amount realized $1,400,000

§1012 Basis (adjusted-§1016) ($400,000)§1001 Gain for Jan Corp. $1,000,000§11(b) Corp. income tax rate 34%

Corp. Fed. Tax payment ($340,000)Other debt payment ($100,000)Total assets - FMV $2,100,000Net distribution to Jan $1,660,000

Jan Corp. Sells Assets.Jan Corp. gain on sale & related income tax

Case 1.

§331 Liquidating distribution is treatedas payment for sale of stock.

Amount of distribution $1,660,000§1012 Jan's stock basis ($300,000)§1001 Gain for Jan $1,360,000§1(h) Cap. Gains tax rate 15%

Jan's Fed. Tax payment $204,000

Jan's liquid. distributionJan's tax effect of liquidating distribution.

Case 1.

§1012 Big Corp's basis for

property purchased from

Jan Corp. is its cost $1,400,000

§1012 Big Corp's Basis $1,400,000

Big Corp. purchased property at FMV.

Big Corp. buys property

Case 2. Jan Corp. collects receivable, pays debt. Jan Liquidates Jan Corp. Jan receives assets. Jan sells land & build. to Big Corp. for $1,400,000.Impact on Jan Corp. Sec. 336. Impact on Jan. Section 331(a). Impact on Jan. Section 334(a). If FMV of fixed asset is $150,000?Impact on Big Corp.

Jan Corp. makes liquidating

distribution of assets to Jan. Case 2.§336(a) Corp. makes liquidating distribution

of appreciated property. Corporationis treated as selling property at FMV.Amount realized $1,400,000

§1012 Basis (adjusted-§1016) ($400,000)§1001 Gain for Jan Corp. $1,000,000§11 Corp. income tax rate 34%

Tax payment ($340,000)Other debt payment ($100,000)Total assets - FMV $2,100,000Net distribution to Jan $1,660,000(Cash and other property)

Case 2.

§331(a) Liquidating distribution is treatedas payment for sale of stock.Amount of distribution-FMV $1,660,000

§1012 Jan's stock basis ($300,000)§1001 Jan's gain on distribution $1,360,000§1(h) Cap. Gains tax rate 15%

Tax payment $204,000§334(a) Jan's property basis-FMV $1,660,000§334(a) Jan's Basis-Land & Bldg $1,400,000

Jan Receives Liq. Dist.Jan's tax effect of liquidating distribution.

Case 2.Jan's Selling Price $1,400,000

§1012 Jan's basis in theland and building ($1,400,000)

§1001 Gain for Jan $0§1(h) Cap. Gains tax rate 15%

Tax payment $0

§1012 Big's basis- its cost $1,400,000

Jan Sells Land & Bldg.

Case 3. Big Corp. buys Jan Corp. stock for $2,000,000 (from Jan).

Impact on Jan.

General Rule. Sec. 61, 1001, 1221.

Impact on Jan Corp.

If section 338 election is not made.

Impact on Jan Corp.

If section 338 election is made.

Impact on Big Corporation?


§1012 Jan's basis in theJan Corp. Stock ($300,000)

§1001 Gain for Jan $1,700,000§1(h) Cap. Gains tax rate 15%

Tax payment $255,000No impact on Jan Corporation if

an election under § 338 is not made.§1012 Big's basis- its cost $2,000,000

Jan Sells Corp. Stock.

Case 3.§338(a). Big corporation can elect to treat the purchase of the stock as the purchase of the underlying assets.

§338(a)(1). Jan Corp. will be treated as selling its assets at price equal to FMV. [This generates gain on sale.]

§338(a)(2). Jan Corp. will be treated as purchasing those assets at FMV.

§338(b). Jan Corp’s basis in assets become FMV.

Case 4. Big Corp. buys Jan Corp. stock for $2,000,000 (from Jan). Big liquidates Jan Corp, receives assets, debt.

Impact on Jan. General Rule. Sec. 61, 1001, 1221.

Impact on Jan Corporation. §337 vs. §336 Jan Corp's gain or loss on distribution of assets to parent corporation?

Impact on Big Corporation. § 332 vs. §331 Big's gain or loss on receipt of assets in liquidation of Jan Corporation.

Big's basis of assets received in liquidation of Jan Corp. § 334(b) vs. §334(a)


§1012 Jan's basis in theJan Corp. Stock ($300,000)

§1001 Gain for Jan $1,700,000§1(h) Cap. Gains tax rate 15%

Tax payment $255,000No impact on Jan Corporation if

an election under § 338 is not made.§1012 Big's basis- its cost $2,000,000

Jan Sells Corp. Stock.

Jan Corp. makes liquidating distribution

of assets to Big Corp. Case 4.Corp. (80% + owned) makes liquidating distribution of property to parent.

§337(a) No gain or loss for liquidating corp.

Jan Corp. has no gain or loss.

Big Corp. receivesliquidating distribution of

assets from Jan Corp. Case 4.Subsidiary Corporation makes liquidating distribution of property to parent.

§332(a) No gain or loss for Big Corp.on receipt of liquidatingdistribution from Jan Corp.

Big Corp. has no gain or loss.

Big Corp. receivesliquidating distribution ofassets from Jan Corp. Case 4.

Subsidiary Corporation makes liquidating distribution of property to parent.

§334(b) Big Corporation's basisin the assets received aresame as Jan Corp's basis.

Big's basis-land & building $400,000

While working with Sec. 11,

read Sec. 12. It may make more sense now that we have covered more

chapters.

TheEnd

Chapter 6B. Corporate Liquidations Howard Godfrey, Ph.D., CPA Professor of Accounting Edited...

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Transcript of Chapter 6B. Corporate Liquidations Howard Godfrey, Ph.D., CPA Professor of Accounting Edited...