Chapter 6 - Liquidations

Question 1

Corporate Liquidation

Answer 1

Occurs when a corporation distributes its net assets to its shareholders and ceases to be a going concern.

Question 2

Generally, a shareholder recognizes a ____________________ upon the liquidation of the entity, regardless of the corporations balance in its earnings and profits account.

Answer 2

Capital Gain or Capital Loss

Question 3

The liquidating corporation recognizes gain and loss on assets that…

Answer 3

it sells during the liquidation period and on assets that it distributes to shareholders in kind

Question 4

The corporation continues solely to…

Answer 4

wind up affairs, pay debts, and distribute any remaining assets to its shareholders

Question 5

A legal dissolution under state law is…

Answer 5

not required.

Question 6

Can a corporation retain a nominal amount of assets during liquidation?

Answer 6

Yes to pay remaining debts and/or preserve its legal status and still liquidate for tax purpose

Question 7

What are the reasons shareholders may decide to liquidate a corporation?

Answer 7

• The business is unsuccessful
• The shareholders want to acquire the corporation’s assets
• Another person wants to purchase the corporation’s assets

Question 8

In the event that another person/entity wants to purchase the corporation’s assets, what can the purchaser do?

Answer 8

1. The purchaser may buy the shareholders’ stock and then liquidate the corporation to acquire the assets.
2. 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.

Question 9

A nonliquidating distribution of noncash property produces…

Answer 9

a gain (but NOT a loss) recognition to the distributing corporation

Question 10

A nonliquidating distribution of noncash property

For the shareholder, the receipt of cash or other property produces…

Answer 10

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.

Question 11

Like a qualifying stock redemption, a liquidation produces…

Answer 11

sale or exchange treatment for the shareholders. E & P has no impact on the gain or loss recognized.

Question 12

Different from a qualifying stock redemption, when liquidating a corporation generally recognizes…

Answer 12

gain AND loss on any assets distributed.

Question 13

Liquidation General Rule

Answer 13

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

Question 14

The liquidation general rule is consistent with the notion of…

Answer 14

double taxation, taxed at the corporate level and again at the shareholder level

Question 15

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…

Answer 15

The liability amount is used to calculate gain/loss

Question 16

Under section 162, liquidation expenses incurred by a corporation are…

Answer 16

deductible as trade or business expenses

Question 17

What are some examples of liquidation expenses?

Answer 17

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

Question 18

Expenses related to the sale of property…

Answer 18

reduce the amount realized on the sale
(brokerage commissions and legal costs incurred in title transfers)

Question 19

What are the 4 exceptions to the general rule of gain and loss recognition by a liquidating corporation?

Answer 19

1. Losses are not recognized on certain liquidating distributions to related-party shareholders
2. 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
3. A subsidiary corporation does not recognize gains or losses on liquidating distributions to its parent company
4. A subsidiary corporation does not recognize losses on liquidating distributions to its minority shareholders

Question 20

The first two exceptions to the general rule of gain/loss recognition of a liquidating corporation are referred to as…

Answer 20

Antistuffing rules

Question 21

Related party

Answer 21

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.

Question 22

Pro Rata Distribution

Answer 22

each shareholder receives proportional interest in property.

Question 23

Disqualified property

Answer 23

property acquired by the corporation within five years of the distribution date in a § 351 or contribution to capital transaction.

Question 24

What is the effect of the antistuffing rules?

Answer 24

Disallow some or all of a loss realized by a corporation in liquidating distributions of certain property

Question 25

Section 362(e)(2)

Answer 25

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

Question 26

When is step-down basis required?

Answer 26

When a shareholder transfers properties having an aggregate basis in excess of their aggregate fair market value

Question 27

Losses are disallowed on liquidating distributions to related arties in either of the following cases:

Answer 27

1. The distribution is NOT pro rata 2. The property distributed is disqualified property

Question 28

Can the related-party limitation apply even if the property was appreciated when it was transferred to the corporation?

Answer 28

Yes

Question 29

The built-in loss limitation applies when both of the following conditions are met:

Answer 29

1. The property was acquired by the corporation in a § 351 (or contribution to capital) transaction. 2. 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.

Question 30

Built-in loss limitation applies only to the extent that...

Answer 30

a property's built-in loss at transfer is not eliminated by a Section 362(e)(2) stepped-down basis

Question 31

Property held by the corporation for more than two years prior to the liquidation is usually...

Answer 31

not subject to the built-in loss limitation

Question 32

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...

Answer 32

there is a clear and substantial business purpose for the transfer

Question 33

When there is a business reason for the transfer...

Answer 33

the built-in loss limitation will not apply

Question 34

Under § 331(a), a liquidating distribution results in sale or exchange treatment for the shareholders. What is the result?

Answer 34

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

Question 35

What is the shareholder's basis of property received in a liquidation?

Answer 35

The property's fair market value on the date of distribution

Question 36

If installment notes are distributed in liquidation...

Answer 36

Shareholders can use the installment method to defer to the point of collection the portion of their gain that is attributable to the notes

Question 37

Taxes paid by a corporation:

Answer 37

1. Reduce the proceeds available to be distributed to the shareholders 2. Reduce the amount realized by the shareholders 3. Reduce gain recognized or increase loss recognized

Question 38

Exception to the general rule 331, 332 provides that a parent corporation...

Answer 38

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

Question 39

What are the three requirements for applying section 332?

Answer 39

1. The parent must own at least 80 percent of the subsidiary’s stock (both voting power and value). 2. 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. 3. The subsidiary must be solvent.

Question 40

If the three requirements of 332 are met...

Answer 40

nonrecognition of gains/losses is mandatory!

Question 41

If the subsidiary is insolvent...

Answer 41

the parent corporation will have an ordinary loss deduction under section 165(g) equal to its basis in the subsidiary stock

Question 42

If the liquidation involves several distributions...

Answer 42

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

Question 43

If the parent fails the 80 percent test at any time...

Answer 43

the provisions for nonrecognition of gain or loss do not apply to any distribution

Question 44

Effect on the Shareholder - § 331

Answer 44

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.

Question 45

Effect on the Shareholder - § 332

Answer 45

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.

Question 46

Basis of Property Received - § 334(a)

Answer 46

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).

Question 47

Basis of Property Received - § 334(b)(1)

Answer 47

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).

Question 48

Basis of Property Received - § 338

Answer 48

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.

Question 49

Effect on the Corporation - § 336

Answer 49

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.

Question 50

Effect on the Corporation - § 337

Answer 50

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.

Question 51

Effect on the Corporation - § 338

Answer 51

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.

Question 52

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

Answer 52

Minority shareholders

Question 53

A distribution of property to a minority shareholder is treated in the same manner as...

Answer 53

A nonliquidating distribution (the subsidiary corporation recognizes gain but NOT loss on the property distributed to the minority shareholder)

Question 54

What is the amount of gain or loss recognized for a minority shareholder?

Answer 54

The difference between the fair market value of the assets received and the basis of the minority shareholder's stock

Question 55

What is the basis of property received by the minority shareholder?

Answer 55

The property's fair market value on the date of distribution

Question 56

If a subsidiary transfers appreciated property to its parent to satisfy a debt...

Answer 56

It must recognize gain on the transaction unless the subsidiary is liquidating and the conditions of § 332 apply.

Question 57

When § 332 applies, the subsidiary...

Answer 57

does not recognize gain or loss upon the transfer of property to the parent in satisfaction of indebtedness

Question 58

The parent corporation recognizes gain or loss on the receipt of property in satisfaction of indebtedness...

Answer 58

even if the property is received during liquidation of the subsidiary

Question 59

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...

Answer 59

makes a § 338 election

Question 60

Liquidation of a subsidiary generally...

Answer 60

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