Chapter 6 - Liquidations Flashcards
Corporate Liquidation
Occurs when a corporation distributes its net assets to its shareholders and ceases to be a going concern.
Generally, a shareholder recognizes a ____________________ upon the liquidation of the entity, regardless of the corporations balance in its earnings and profits account.
Capital Gain or Capital Loss
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
The corporation continues solely to…
wind up affairs, pay debts, and distribute any remaining assets to its shareholders
A legal dissolution under state law is…
not required.
Can a corporation retain a nominal amount of assets during liquidation?
Yes to pay remaining debts and/or preserve its legal status and still liquidate for tax purpose
What are the reasons shareholders may decide to liquidate a corporation?
- The business is unsuccessful
- The shareholders want to acquire the corporation’s assets
- Another person wants to purchase the corporation’s assets
In the event that another person/entity wants to purchase the corporation’s assets, what can the purchaser do?
- The purchaser may buy the shareholders’ stock and then liquidate the corporation to acquire the assets.
- Alternatively, the purchaser may buy the assets directly from the corporation. After the assets are sold, the corporation distributes the sales proceeds to its shareholders and liquidates.
A nonliquidating distribution of noncash property produces…
a gain (but NOT a loss) recognition to the distributing corporation
A nonliquidating distribution of noncash property
For the shareholder, the receipt of cash or other property produces…
dividend income to the extent of the corporation’s E & P or, in the case of a qualifying stock redemption, results in sale or exchange treatment.
Like a qualifying stock redemption, a liquidation produces…
sale or exchange treatment for the shareholders. E & P has no impact on the gain or loss recognized.
Different from a qualifying stock redemption, when liquidating a corporation generally recognizes…
gain AND loss on any assets distributed.
Liquidation General Rule
Under section 336a, a corporation recognizes gain/loss on the distribution of property in a complete liquidation as if the property were sold at its fair market value
The liquidation general rule is consistent with the notion of…
double taxation, taxed at the corporate level and again at the shareholder level
As in the case of a nonliquidating distribution, if distributed property is subject to a corporate liability that is greater than the fair market value of the property…
The liability amount is used to calculate gain/loss
Under section 162, liquidation expenses incurred by a corporation are…
deductible as trade or business expenses
What are some examples of liquidation expenses?
accounting and legal costs of drafting and implementing a plan of liquidation, the cost of revoking the corporation’s charter, and the basis of abandoned assets
Expenses related to the sale of property…
reduce the amount realized on the sale
(brokerage commissions and legal costs incurred in title transfers)
What are the 4 exceptions to the general rule of gain and loss recognition by a liquidating corporation?
- Losses are not recognized on certain liquidating distributions to related-party shareholders
- Losses are not recognized on certain sales and property that was contributed to the corporation with a build-in loss shortly before the adoption of a plan of liquidation
- A subsidiary corporation does not recognize gains or losses on liquidating distributions to its parent company
- A subsidiary corporation does not recognize losses on liquidating distributions to its minority shareholders
The first two exceptions to the general rule of gain/loss recognition of a liquidating corporation are referred to as…
Antistuffing rules
Related party
if shareholder owns directly or indirectly more than 50% in value of the stock
Code § 267 attribution rules apply. Similar to § 318 attribution rules but includes stock owned by siblings.
Pro Rata Distribution
each shareholder receives proportional interest in property.
Disqualified property
property acquired by the corporation within five years of the distribution date in a § 351 or contribution to capital transaction.
What is the effect of the antistuffing rules?
Disallow some or all of a loss realized by a corporation in liquidating distributions of certain property
Section 362(e)(2)
Requires a corporation to reduce (step-down) the basis of a property acquired in a Section 351 or contribution to capital transaction by the amount of any net built-in loss embodied in such property
When is step-down basis required?
When a shareholder transfers properties having an aggregate basis in excess of their aggregate fair market value
Losses are disallowed on liquidating distributions to related arties in either of the following cases:
- The distribution is NOT pro rata
- The property distributed is disqualified property
Can the related-party limitation apply even if the property was appreciated when it was transferred to the corporation?
Yes
The built-in loss limitation applies when both of the following conditions are met:
- The property was acquired by the corporation in a § 351 (or contribution to capital) transaction.
- This acquisition was part of a plan whose principal purpose was to recognize a loss on that property by the liquidating corporation. A tax avoidance purpose is presumed in the case of transfers occurring within two years of a liquidation plan being adopted.
Built-in loss limitation applies only to the extent that…
a property’s built-in loss at transfer is not eliminated by a Section 362(e)(2) stepped-down basis
Property held by the corporation for more than two years prior to the liquidation is usually…
not subject to the built-in loss limitation
The presumption of a tax avoidance purpose for property transferred to a corporation in the “two years prior to liquidation” window can be contested if…
there is a clear and substantial business purpose for the transfer
When there is a business reason for the transfer…
the built-in loss limitation will not apply
Under § 331(a), a liquidating distribution results in sale or exchange treatment for the shareholders. What is the result?
the difference between the fair market value of the assets received from the corporation and the adjusted basis of the stock surrendered is the gain or loss recognized by the shareholder
What is the shareholder’s basis of property received in a liquidation?
The property’s fair market value on the date of distribution
If installment notes are distributed in liquidation…
Shareholders can use the installment method to defer to the point of collection the portion of their gain that is attributable to the notes
Taxes paid by a corporation:
- Reduce the proceeds available to be distributed to the shareholders
- Reduce the amount realized by the shareholders
- Reduce gain recognized or increase loss recognized
Exception to the general rule 331, 332 provides that a parent corporation…
Does not recognize gain/loss on a liquidation of a subsidiary. The subsidiary corporation recognizes neither gain nor loss on liquidating distributions of property to its parent
What are the three requirements for applying section 332?
- The parent must own at least 80 percent of the subsidiary’s stock (both voting power and value).
- All of the subsidiary’s property must be distributed in complete cancellation of all of its stock within the taxable year or within three years from the close of the tax year in which the first distribution occurred.
- The subsidiary must be solvent.
If the three requirements of 332 are met…
nonrecognition of gains/losses is mandatory!
If the subsidiary is insolvent…
the parent corporation will have an ordinary loss deduction under section 165(g) equal to its basis in the subsidiary stock
If the liquidation involves several distributions…
the 80 percent test must be met on the date the plan of liquidation is adopted and maintained until the final liquidating distribution is received by the parent
If the parent fails the 80 percent test at any time…
the provisions for nonrecognition of gain or loss do not apply to any distribution
Effect on the Shareholder - § 331
The general rule provides for gain or loss treatment on the difference between the FMV of property received and the basis of the stock in the corporation. Gain allocable to installment notes received can be deferred to the point of collection.
Effect on the Shareholder - § 332
In liquidation of a subsidiary, no gain or loss is recognized by the parent. Subsidiary must distribute all of its property within the taxable year or within three years from the close of the taxable year in which the first distribution occurs. Minority shareholders are taxed under the general rule of § 331.
Basis of Property Received - § 334(a)
Basis of assets received by the shareholder will be the FMV on the date of distribution (except for installment obligations on which gain is deferred to the point of collection).
Basis of Property Received - § 334(b)(1)
Property has the same basis that it had in the hands of the subsidiary. Parent’s basis in the stock disappears. Carryover rules of § 381 apply. Minority shareholders get FMV basis under § 334(a).
Basis of Property Received - § 338
Subsidiary need not be liquidated. If subsidiary is liquidated, parent’s basis in the assets is the new stepped-up (or -down) basis. Parent’s basis in the stock disappears. Carryover rules of § 381 apply, but such amounts are likely to be nominal.
Effect on the Corporation - § 336
Gain or loss is recognized for distributions in kind and for sales by the liquidating corporation. Losses are not recognized for distributions to related parties if the distribution is not pro rata or if disqualified property is distributed. Losses may be disallowed on sales and distributions of built-in loss property even if made to unrelated parties.
Effect on the Corporation - § 337
No gain or loss is recognized by the subsidiary on distributions to the parent. Gain (but not loss) is recognized on distributions to minority shareholders.
Effect on the Corporation - § 338
Gain or loss is recognized by the subsidiary. Subsidiary is treated as a new corporation, and its basis in the assets is stepped up (or down) to reflect the parent’s basis in the subsidiary stock plus subsidiary’s liabilities. New basis is allocated among various asset classes.
In a § 332 parent-subsidiary liquidation, up to 20 percent of the subsidiary’s stock can be owned by…
Minority shareholders
A distribution of property to a minority shareholder is treated in the same manner as…
A nonliquidating distribution
(the subsidiary corporation recognizes gain but NOT loss on the property distributed to the minority shareholder)
What is the amount of gain or loss recognized for a minority shareholder?
The difference between the fair market value of the assets received and the basis of the minority shareholder’s stock
What is the basis of property received by the minority shareholder?
The property’s fair market value on the date of distribution
If a subsidiary transfers appreciated property to its parent to satisfy a debt…
It must recognize gain on the transaction unless the subsidiary is liquidating and the conditions of § 332 apply.
When § 332 applies, the subsidiary…
does not recognize gain or loss upon the transfer of property to the parent in satisfaction of indebtedness
The parent corporation recognizes gain or loss on the receipt of property in satisfaction of indebtedness…
even if the property is received during liquidation of the subsidiary
Property received by the parent corporation in the complete liquidation of a subsidiary has the same basis it had in the hands of the subsidiary. Unless the parent corporation…
makes a § 338 election
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
