Chapter 20

Question 1

Liquidations—In General

Answer 1

• Corporation winds up affairs, pays debts, and distributes remaining assets to shareholders
– Produces sale or exchange treatment to shareholder
– Liquidating corporation recognizes gains and losses upon distribution of its assets, with certain exceptions

Question 2

Liquidations—Effect on Corporation (slide 1 of 3)

Answer 2

• Gain or loss is recognized by corporation on distribution in complete liquidation
– Loss may be disallowed or limited if:
• Property distributed to related parties
• Property distributed has built-in losses
• A subsidiary’s liquidating distribution to its parent corporation or to its minority shareholders
– Property treated as if sold for FMV
– Result: Liquidating distribution subject to corporate level tax (gain), and shareholder level tax (receipt of proceeds)

Question 3

Liquidations—Effect on Corporation (slide 1 of 3)

Answer 3

• Gain or loss is recognized by corporation on distribution in complete liquidation
– Loss may be disallowed or limited if:
• Property distributed to related parties
• Property distributed has built-in losses
• A subsidiary’s liquidating distribution to its parent corporation or to its minority shareholders
– Property treated as if sold for FMV
– Result: Liquidating distribution subject to corporate level tax (gain), and shareholder level tax (receipt of proceeds)

Question 4

Liquidations—Effect on Corporation (slide 2 of 3)

Answer 4

• Limitations on losses—Related Party Situations
– Losses are disallowed on liquidating distributions to related parties if:
• Distribution is not pro rata
– In pro rata distributions, each shareholder receives their share of each asset
• Property distributed is disqualified property
– Disqualified property is property acquired by corp in a §351 transaction during the five-year period ending on date of distribution

Question 5

Liquidations—Effect on Corporation (slide 3 of 3)

Answer 5

• Limitations on losses—Built-in Loss Situations
– Losses are disallowed when property distributed was acquired in a §351 transaction and principal purpose was to cause recognition of loss by corp on liquidation
– Purpose is presumed if transfer occurs within two years of adopting liquidation plan

Question 6

Liquidations—Effect on Shareholder (slide 1 of 2)

Answer 6

• Gain or loss recognized on receipt of property from liquidating corporation
– Amount = FMV of property received - basis in stock
• Generally, capital gain or loss
– Basis in assets received in liquidating distribution = FMV on date of distribution

Question 7

Liquidations—Effect on Shareholder (slide 2 of 2)

Answer 7

– Special rule for installment obligations
• Shareholder may defer gain recognition to point of collection
• Corporation must recognize all gain on distribution

Question 8

Liquidations: Parent-Subsidiary Situations (slide 1 of 4)

Answer 8

• Parent corporation does not recognize gain or loss on liquidation of subsidiary
– Also, subsidiary recognizes no gain or loss on property distributions to its parent

Question 9

Liquidations: Parent-Subsidiary Situations (slide 2 of 4)

Answer 9

• To qualify:
– Parent must own at least 80% of voting stock and value of subsidiary’s stock
– Subsidiary must distribute all property in complete cancellation of all its stock within the taxable year or within 3 years from the close of tax year in which first distribution occurred
– Subsidiary must be solvent

Question 10

Liquidations: Parent-Subsidiary Situations (slide 3 of 4)

Answer 10

• Liquidating distributions to minority shareholders
– Subsidiary corporation treated same way as in nonliquidating distribution
• Distributing corp recognizes gain but not loss
– Minority shareholders recognize gain or loss
• Amount = FMV of property received - basis in stock

Question 11

Liquidations: Parent-Subsidiary Situations (slide 4 of 4)

Answer 11

• Basis of property received by parent
– Has same basis as subsidiary’s basis (unless election is made under §338)
• Parent’s basis in subsidiary’s stock disappears
• Parent acquires tax attributes of subsidiary.
– e.g., NOLs, business credit carryovers, capital loss carryovers, subsidiary’s E & P
• May result in some inequities

Question 12

Election Under §338 (slide 1 of 4)

Answer 12

• Parent may elect to treat acquisition of stock in acquired corp as a purchase of the acquired corp.’s assets if:
– Election is made by fifteenth day of ninth month following qualified stock purchase
• Qualified stock purchase occurs when corp acquires stock representing at least 80% of voting power and value within a 12-month period
• Must be acquired in taxable transaction
– Stock purchases by affiliated group members count

Question 13

Election Under §338(slide 2 of 4)

Answer 13

• Tax Consequences
– Parent corp. has basis in subsidiary’s assets = basis in subsidiary’s stock
• Subsidiary may, but need not, be liquidated

Question 14

Election Under §338(slide 3 of 4)

Answer 14

• Tax Consequences (cont’d)
– Subsidiary is deemed to have sold its assets for an amount determined with reference to parent’s basis in subsidiary’s stock, adjusted for liabilities of subsidiary

Question 15

Election Under §338(slide 4 of 4)

Answer 15

• Tax Consequences (cont’d)
– Gain or loss is recognized by subsidiary
– Subsidiary is treated as a new corporation that purchased all of its assets on the day after the qualified stock purchase date

Question 16

Reorganizations—In General

Answer 16

• Refers to any corporate restructuring that may be tax-free under §368
– To qualify, must meet certain general requirements:.
• Must have a plan of reorganization
• Must meet continuity of interest and continuity of business enterprise tests
• Must have a sound business purpose
•Step transaction doctrine should not apply to the reorganization

Question 17

Summary of Different Types of Reorganizations

Answer 17

• The term reorganization includes:
– Type A: Statutory merger or consolidation
– Type B: Stock for stock exchange
– Type C: Stock for assets exchange
– Type D: Divisive exchange
– Type E: Recapitalization
– Type F: Change in identity, form, or place of organization
– Type G: Transfers in bankruptcy or receivership

Question 18

Tax Free Reorganization Consequences, in General (slide 1 of 3)

Answer 18

• Consequences to Acquiring Corporation
– No gain or loss recognized unless it transfers property to the target corporation as part of the transaction
• Then gain, but not loss, may be recognized
– Basis of property received retains basis it had in hands of target corp. plus any gain recognized by the target

Question 19

Tax Free Reorganization Consequences, in General (slide 2 of 3)

Answer 19

• Consequences to Target Corporation
– No gain or loss unless it retains “other property” received in the exchange or it distributes its own property to shareholders
• Other property is defined as anything received other than stock or securities
– Treated as boot
• Gain, but not loss, may be recognized

Question 20

Tax Free Reorganization Consequences, in General (slide 3 of 3)

Answer 20

• Consequences to Target or Acquiring Co. Shareholders
– No gain or loss unless shareholders receive cash or other property in addition to stock
• Cash or other property is considered boot
– Gain recognized by the stockholder is the lesser of the boot received or the realized gain
– Basis of shares received is same as basis of those surrendered, decreased by boot received, increased by gain and dividend income, if any, recognized in the transaction

Question 21

E & P impacts the gain or loss to be recognized by the shareholder in a liquidating distribution but not in a nonliquidating distribution.

True
False

Answer 21

False

E & P has no impact on the gain or loss to be recognized by the shareholder in either type of distribution.

Question 22

Under § 336(a), a corporation recognizes gain or loss on the distribution of property in a complete liquidation as if the property were sold at its fair market value.

True
False

Answer 22

True

This treatment is consistent with the notion of double taxation that is inherent in operating a business as a C corporation—once at the corporate level and again at the shareholder level.

Question 23

During the current year, Crow Corporation is liquidated and distributes its only asset, land, to Cody, the sole shareholder. On the date of distribution, the land has a basis of $300,000, has a fair market value of $650,000, and is subject to a liability of $400,000. Cody, who takes the land subject to the liability, has a basis of $75,000 in the Crow stock. With respect to the distribution of the land, which of the following statements is correct?

a. Cody has a basis of $250,000 in the land.
b. Cody recognizes a gain of $175,000.
c. Cody has a basis of $300,000 in the land.
d. Cody recognizes a gain of $575,000.
e. Crow Corporation recognizes a gain of $100,000.

Answer 23

B

In a complete liquidation, a shareholder recognizes gain equal to the difference between the fair market value of property received from the corporation and the basis of the stock surrendered. When property is received subject to a liability, such liability reduces the amount realized by the shareholder. Thus, Cody recognizes a gain of $175,000 [$250,000 (net fair market value of land) – $75,000 (basis in Crow stock)]. Crow recognizes a gain of $350,000 [$650,000 (fair market value) – $300,000 (basis)] on the distribution of land. Cody’s basis in the land is its fair market value on the date of the distribution, or $650,000.

Question 24

The liquidation of a subsidiary generally is a nontaxable transaction.

True
False

Answer 24

True

The liquidation of a subsidiary generally is a nontaxable transaction resulting in the nonrecognition of gain or loss for both the parent and the subsidiary corporations and the carryover of the subsidiary’s asset bases (and other tax attributes).

Question 25

The stock of Puffin Corporation is held as follows: 90 percent by Quartz Corporation (basis of $500,000) and 10 percent by Corey (basis of $70,000). Puffin Corporation is liquidated on October 20, 2017, pursuant to a plan adopted on January 8, 2017. Pursuant to the liquidation, Puffin Corporation distributed Asset A (basis of $450,000, fair market value of $720,000) to Quartz and Asset B (basis of $45,000, fair market value of $80,000) to Corey. No election is made under § 338. With respect to the liquidation of Puffin:

a. Quartz recognizes a gain of $220,000.
b. Puffin Corporation recognizes a gain of $35,000.
c. Corey recognizes no gain (or loss).
d. Quartz has a basis in Asset A of $720,000.
e. None of these choices are correct.

Answer 25

B

In distributions from a subsidiary corporation to a minority shareholder, pursuant to a § 332 parent-subsidiary liquidation, gains (but not losses) are recognized. Thus, Puffin recognizes a gain of $35,000 on the distribution of Asset B to Corey [$80,000 (fair market value) – $45,000 (basis in Asset B)]. Corey’s tax consequences are governed under § 331 where sale or exchange treatment results in a recognized gain of $10,000 [$80,000 (fair market value of Asset B) – $70,000 (basis in stock)]. The liquidating distribution of Asset A to Quartz is pursuant to a § 332 parent-subsidiary liquidation; thus, Puffin does not recognize any gain on the distribution, and Quartz takes a carryover basis in the asset, or $450,000.

Question 26

In a § 332 parent-subsidiary liquidation, up to 20 percent of the subsidiary’s stock can be owned by minority shareholders.

True
False

Answer 26

True

In such liquidations, a distribution of property to a minority shareholder is treated in the same manner as a nonliquidating distribution.

Question 27

In order for a corporate reorganization to qualify for tax free treatment under § 368, a sound business purpose need not be shown.

True
False

Answer 27

False

The judicial doctrine of having a sound business purpose must be met.

Question 28

The tax free reorganization provisions of § 368 closely parallel those governing like-kind exchanges of real property in § 1031.

True
False

Answer 28

True

The basic rules of both sections are very similar.

Question 29

Barite Corporation acquires all of Brass Corporation’s stock in exchange for its voting stock. Trever received 1,000 shares of Barite valued at $50,000 for her 8,000 shares of Brass that cost Trever $100,000 five years ago. In addition to the Barite stock, she receives a $30,000 bond. How does Trever treat this transaction for tax purposes?

a. Trever realizes a $20,000 loss that is not recognized. Her Barite stock basis is $120,000.
b. Trever recognizes a $20,000 loss and a $25,000 gain. Her Barite stock basis is $105,000.
c. Trever recognizes a loss of $50,000. Her Barite stock basis is $50,000.
d. Trever recognizes a loss of $20,000. Her Barite stock basis is $80,000.
e. None of these choices are correct.

Answer 29

E,

Trever has a realized loss of $20,000; however, losses are not recognized in reorganizations. Her basis in her Barite stock will be $70,000 ($100,000 – $30,000 bond received).

Question 30

For a parent corporation to achieve control of a subsidiary corporation for the purposes of § 332, the parent corporation must own at least 90 percent of the subsidiary’s stock.

True
False

Answer 30

False

The requirement is only 80 percent.

Question 31

Two years ago, Sherry, the sole shareholder of Canary Corporation (E & P of $600,000), received a nontaxable stock dividend of 100 shares of preferred stock (fair market value of $100,000) from Canary. As a result of the stock dividend, Sherry properly allocated $30,000 of her common stock basis to the preferred stock. One year ago, Sherry made a gift of the preferred stock in Canary Corporation to her son, Chandler. In the current year, Chandler sells one-half of the shares of preferred stock to Julia, an unrelated party, for $50,000. With respect to the sale of the preferred stock by Chandler:

a. Chandler will recognize a capital gain of $35,000.
b. Chandler will recognize ordinary income of $50,000.
c. Chandler will recognize ordinary income of $0.
d. Chandler will recognize ordinary income of $35,000.
e. None of these choices are correct.

Answer 31

B

The preferred stock was § 306 stock in Sherry’s hands, and the § 306 taint ($100,000) transfers with the stock upon its gift to Chandler. When Chandler sells 50 shares of the preferred stock to Julia, he recognizes $50,000 of ordinary income (the § 306 taint allocable to one-half of the shares). (The $15,000 basis allocated to the basis of the shares sold is presumably allocated to the basis of the remaining 50 shares of preferred stock held by Chandler.)

Question 32

A § 332 liquidation could occur in the case of a bankrupt subsidiary corporation.

True
False

Answer 32

False

The subsidiary must be solvent.

Question 33

A corporate liquidation exists when a corporation ceases to be a going concern.

True
False

Answer 33

True

The corporation continues solely to wind up affairs, pay debts, and distribute any remaining assets to its shareholders. The corporation need not liquidate.

Question 34

The stock in Lamprey Corporation is owned equally by Donald and his son Richard. In a liquidation of the corporation, Lamprey Corporation distributes to Donald land that it purchased three years ago for $550,000. The property has a fair market value on the date of distribution of $400,000. Later, Donald sells the land for $420,000. What loss will Lamprey Corporation recognize with respect to the distribution of the land?

a. $20,000.
b. $150,000.
c. $130,000.
d. $0.
e. None of these choices are correct.

Answer 34

0

Donald is deemed to own 100 percent of the stock of Lamprey Corporation—50 percent directly and 50 percent indirectly from Richard. As a result, there is a distribution of loss property to a related party and the distribution is not pro rata. The related-party loss limitation therefore applies to disallow the entire $150,000 loss realized on the distribution ($400,000 fair market value – $550,000 basis).

Question 35

Liquidation expenses incurred by a corporation are deductible as trade or business expenses under § 162.

True
False

Answer 35

True

Examples include accounting and legal costs of drafting and implementing a plan of liquidation and the cost of revoking the corporation’s charter.

Question 36

A § 332 liquidation could occur in the case of a bankrupt subsidiary corporation.

True
False

Answer 36

False

The subsidiary must be solvent.

Question 37

Two years ago, Sherry, the sole shareholder of Canary Corporation (E & P of $600,000), received a nontaxable stock dividend of 100 shares of preferred stock (fair market value of $100,000) from Canary. As a result of the stock dividend, Sherry properly allocated $30,000 of her common stock basis to the preferred stock. One year ago, Sherry made a gift of the preferred stock in Canary Corporation to her son, Chandler. In the current year, Chandler sells one-half of the shares of preferred stock to Julia, an unrelated party, for $50,000. With respect to the sale of the preferred stock by Chandler:

a. Chandler will recognize a capital gain of $35,000.
b. Chandler will recognize ordinary income of $50,000.
c. Chandler will recognize ordinary income of $35,000.
d. Chandler will recognize ordinary income of $0.
e. None of these choices are correct.

Answer 37

b

The preferred stock was § 306 stock in Sherry’s hands, and the § 306 taint ($100,000) transfers with the stock upon its gift to Chandler. When Chandler sells 50 shares of the preferred stock to Julia, he recognizes $50,000 of ordinary income (the § 306 taint allocable to one-half of the shares). (The $15,000 basis allocated to the basis of the shares sold is presumably allocated to the basis of the remaining 50 shares of preferred stock held by Chandler.)

Question 38

In the sale of § 306 stock to a third party, no loss can be recognized.

True
False

Answer 38

True

No loss would be recognized in this situation.

Question 39

Liquidation expenses incurred by a corporation are deductible as trade or business expenses under § 162.

True
False

Answer 39

True

Examples include accounting and legal costs of drafting and implementing a plan of liquidation and the cost of revoking the corporation’s charter.

Question 40

Losses are recognized on nonliquidating distributions of property.

True
False

Answer 40

False

Losses are not recognized on nonliquidating distributions of property.

Question 41

Pursuant to a complete liquidation, Swallow Corporation distributes to its shareholders land with a basis of $450,000 and a fair market value of $550,000. The land is subject to a liability of $600,000. Swallow’s recognized gain or loss on the distribution is:

a. a $100,000 gain.
b. $0.
c. a $50,000 loss.
d. a $150,000 gain.
e. None of these choices are correct.

Answer 41

D

Section 336 provides that a liquidating corporation recognizes gain or loss on the distribution of property in complete liquidation. When property distributed in a complete liquidation is subject to a liability of the liquidating corporation, the fair market value of the property cannot be less than the amount of the liability. Thus, Swallow recognizes a gain of $150,000 [$600,000 (liability) – $450,000 (land basis)].

Question 42

Under § 336(a), a corporation recognizes gain or loss on the distribution of property in a complete liquidation as if the property were sold at its fair market value.

True
False

Answer 42

True

This treatment is consistent with the notion of double taxation that is inherent in operating a business as a C corporation—once at the corporate level and again at the shareholder level.

Question 43

During the current year, Crow Corporation is liquidated and distributes its only asset, land, to Cody, the sole shareholder. On the date of distribution, the land has a basis of $300,000, has a fair market value of $650,000, and is subject to a liability of $400,000. Cody, who takes the land subject to the liability, has a basis of $75,000 in the Crow stock. With respect to the distribution of the land, which of the following statements is correct?

a. Cody has a basis of $250,000 in the land.
b. Cody recognizes a gain of $175,000.
c. Crow Corporation recognizes a gain of $100,000.
d. Cody recognizes a gain of $575,000.
e. Cody has a basis of $300,000 in the land.

Answer 43

B

In a complete liquidation, a shareholder recognizes gain equal to the difference between the fair market value of property received from the corporation and the basis of the stock surrendered. When property is received subject to a liability, such liability reduces the amount realized by the shareholder. Thus, Cody recognizes a gain of $175,000 [$250,000 (net fair market value of land) – $75,000 (basis in Crow stock)]. Crow recognizes a gain of $350,000 [$650,000 (fair market value) – $300,000 (basis)] on the distribution of land. Cody’s basis in the land is its fair market value on the date of the distribution, or $650,000.

Question 44

E & P impacts the gain or loss to be recognized by the shareholder in a liquidating distribution but not in a nonliquidating distribution.

True
False

Answer 44

False

E & P has no impact on the gain or loss to be recognized by the shareholder in either type of distribution

Question 45

If a parent corporation makes a § 338 election, the subsidiary corporation must be liquidated.

True
False

Answer 45

False

The subsidiary corporation may, but need not, be liquidated as a result of the § 338 election. If the subsidiary is liquidated, the parent obtains the subsidiary’s assets with the stepped-up (or -down) basis.

Question 46

Brook Corporation owns 90 percent of the outstanding stock of Herring Corporation, having purchased the stock five years ago for $550,000. Pursuant to a plan of liquidation adopted by Herring Corporation on March 4, 2018, Herring distributes all its property on December 1, 2018, to its shareholders. Herring Corporation had never been insolvent and had E & P of $830,000 on the date of liquidation. Pursuant to the liquidation, Herring distributed property worth $690,000 (basis $580,000) to Brook Corporation. How much gain must the parties recognize in 2018 on the transfer of this property to Brook Corporation?

a. $0 as to Brook and $110,000 as to Herring.
b. $140,000 as to Brook and $110,000 as to Herring.
c. $30,000 as to Brook and $110,000 as to Herring.
d. $140,000 as to Brook and $0 as to Herring.
e. None of these choices are correct.

Answer 46

E

Pursuant to §§ 332 and 337, neither Brook Corporation nor Herring Corporation recognizes gain as a result of the liquidating distribution.

Question 47

Sunfish Corporation purchased bonds (basis of $95,000) of its 100 percent owned subsidiary, Walleye Corporation, at a discount. Pursuant to a § 332 liquidation and in satisfaction of the indebtedness, Walleye distributes land worth $100,000 (basis of $110,000) to Sunfish. Which of the following statements is correct with respect to the distribution of land?

a. Walleye recognizes a loss of $10,000 and Sunfish recognizes no gain.
b. Neither Walleye nor Sunfish recognizes gain (or loss).
c. Walleye recognizes no loss and Sunfish recognizes a gain of $5,000.
d. Walleye recognizes a loss of $10,000 and Sunfish recognizes a gain of $5,000.
e. None of these choices are correct.

Answer 47

C

Sunfish recognizes a gain of $5,000 [$100,000 (value of land) – $95,000 (basis in bonds)]. Walleye recognizes no gain or loss on distributions pursuant to a § 332 liquidation, even if property is transferred in satisfaction of indebtedness to Sunfish.

Question 48

Occurs when a corporation distributes its net assets to its shareholders and ceases to be a going concern. Generally, a shareholder recognizes capital gain or loss upon the liquidation of the entity, regardless of the corporation’s balance in its earnings and profits account. The liquidating corporation recognizes gain and loss on assets that it sells during the liquidation period and on assets that it distributes to shareholders in kind.

Answer 48

Corporate liquidation

Question 49

When a corporation acquires at least 80 percent of a subsidiary within a 12-month period, it can elect to treat the acquisition of such stock as an asset purchase. The acquiring corporation’s basis in the subsidiary’s assets then is the cost of the stock. The subsidiary is deemed to have sold its assets for an amount equal to the grossed-up basis in its stock.

Answer 49

S 338 election

Question 50

Any corporate restructuring, including when one corporation acquires another, a single corporation divides into two or more entities, a corporation makes a substantial change in its capital structure, a corporation undertakes a change in its legal name or domicile, or a corporation goes through a bankruptcy proceeding and continues to exist. The exchange of stock and other securities in a corporate reorganization can be effected favorably for tax purposes if certain statutory requirements are followed strictly. Tax consequences include the nonrecognition of any gain that is realized by the shareholders except to the extent of boot received. § 368.

Answer 50

reorganization

Question 51

In a corporate reorganization, any property in the exchange that is not stock or securities, such as cash or land. This amount constitutes boot. This treatment is similar to that in a like-kind exchange.

Answer 51

Other property

Question 52

Cash or property of a type not included in the definition of a tax-deferred exchange. The receipt of boot causes an otherwise tax-deferred transfer to become immediately taxable to the extent of the lesser of the fair market value of the boot or the realized gain on the transfer. For example, see transfers to controlled corporations under § 351(b), reorganizations under § 368, and like-kind exchanges under § 1031(b).

Answer 52

boot

Question 53

When a corporation acquires at least 80 percent of a subsidiary within a 12-month period, it can elect to treat the acquisition of such stock as an asset purchase. The acquiring corporation’s basis in the subsidiary’s assets then is the cost of the stock. The subsidiary is deemed to have sold its assets for an amount equal to the grossed-up basis in its stock.

Answer 53

Section 338 election