Chapter 7- Corporate Complete
The Structure of Part II
of Subchapter C
Subpart A - Effects on
§§331, 332, &
Subpart B - Effects on the
§§336, 337 &
Subpart C - §341 - Repealed
Subpart D - Definitions
Liquidation vs. Dissolution
Liquidation as a tax
concept – termination of corporate activities, satisfaction of liabilities, and
distribution of the corporation’s assets.
Dissolution – a state
law concept (termination of the charter). See Texas Business Corporation
Act, §6.01 et. seq. concerning a voluntary corporate dissolution (& TBOC
§11.01 re “winding up,” year 2010).
Options for Shareholder
Taxation in a Liquidation
1) Non-recognition -
reverse the earlier §351 treatment? But, how deal with the cash?
2) Dividend distribution
to the extent of E&P?
But, how deal with
recovery of tax basis?
treatment, i.e., stock sale and tax basis recovery. Similar to redemption
treatment qualifying as a “sale or exchange” under §302(b)? But, then what
treatment of the E&P account? Disappears?
Treatment for Liquidation Distribution
§331(a) – a complete
liquidation enables “sale or exchange” income tax treatment to the shareholder
of liquidating corporation.
§334(a) - tax basis to the
shareholder for any property received in a liquidation is its FMV at the time
of the liquidation distribution.
Timing issues: (i) installment
obligations distributed- §453(h)(1)(A); and; (ii) creeping liquidation
distributions (& cost recovery)?
A owns 100 shares of Humdrum
Corp. purchased for $10,000 (i.e., tax basis).
Humdrum has $12,000 accumulated
Humdrum distributes $20,000 to
A in exchange for A’s stock in its liquidation.
Result: $10,000 LTCG under
($20,000 received less $10,000
E&P is not relevant for
Several Liquidation Payments
$10,000 is received in two
Timing question: See Rev.
Rul. 85-48 which permits full recovery of tax basis before reporting
any gain (i.e., “open transaction” treatment appears available).
Cf., Code §453(j)(2) - ratable
tax basis recovery is required - even when the selling price is not readily
Humdrum distributes $8,000 cash
and an installment obligation of $12,000, payable $1,000 per year for 12
years, with market rate interest. $10x basis. The obligation is received by
Humdrum upon its sale of a capital asset after liquidation plan adopted.
Gain of $10,000 is realized
on the liquidation. Shareholder may report gain on installment note under
Installment sales reporting
4,000 LTCG of the 8,000 cash
500 LTCG of each later
tax reporting treatment:
Basis recovery for 8,000
and remainder of the transaction reported on installment basis.
Publicly traded stock: §453 is
not available; §453(k)(2)(A). & 10,000 immediate gain.
Installment Note Received
Installment obligation was
received two years ago and no payment has been made on the obligation.
Sale within 12 month’s of liquidation limit is applicable -
Installment method is not
A would: (1) recognize 10,000
LTCG (20,000 less 10,000 basis) and (2) take a $12,000 basis in the installment
obligation under §334(a).
Later Payment of Judgment
1) A required to pay $5,000
judgment against Humdrum in his capacity as a transferee.
Arrowsmith case -
must take a $5,000 LTCL.
The tax characterization
2) If paid by corporation prior
For the corporation - (i)
producing a $5,000 ordinary deduction, and (ii) reducing the net proceeds by
$5,000 (less $1,750 tax benefit).
Consequences to the Liquidating
Issue: Does a
distribution of property in kind in a complete liquidation trigger gain
recognition to the distributor corporation as to the distributed asset?
§336(a) - (1) requires recognition by the distributing corporation of accrued
property gain and (2) provides for the availability (in some situations)
of a loss deduction. Reversing former §337.
Historical Perspective -
Corporate Level Gain Tax
1) Commissioner v. Court
Substance of the transaction
was a sale of an apartment house (corporation's sole asset) by
the corporation, not the shareholders.
2) U.S. v. Cumberland Public
Service Co. Property transferred to shareholders as a liquidation distribution
Held: Sale by shareholders and
not by the corporation (and no corporate level gain).
Response to Court Holding
1) Former Code
§337 – anti-Court Holding provision enabled income tax immunity for sales of
corporate assets after adoption of the liquidation plan.
response: 1986 repeal of General Utilities rule & gain recognition
required at corporate level for all asset sales – including after liquidation
plan adoption. Code §336.
Limitations on Corporate Loss
Loss can be recognized
Cf., §311 - no loss can be
recognized when a corporate distribution is not in liquidation.
Certain losses are allowed even
though §267 loss limitation may apply to transfers of loss property between
Double loss may be permitted
(corporation & shareholder levels) - after a §351 dropdown of loss
property. But, note: §362(e)(2).
Corporate Loss Deduction Availability
Related persons: 1)
If distribution is not prorata. §336(d)(1)(A)(i).
2) Where the property is
acquired by corporation within five years of distribution. “Anti-stuffing
§336(d)(2) - losses with a “tax avoidance” motive. Only those losses accruing after
contribution to the corporation are allowed.
Prorata Asset Distributions
Gainacre $300,000 accrued
distribution to tenants in common.
$300,000 gain is recognized
by X Corp.
$400,000 loss is also
recognized by X Corp.
§336(d) loss limitation rule is
not applicable (assets have been held for five years).
Loss asset to majority owner
Lossacre and cash to Ivan;
Gainacre to Flo.
Gain is recognized by X
Corporation on the transfer to Flo - §336(a).
Loss is not recognized
since: (1) distribution is not pro rata - §336(d)(1)(A)(i) &
(2) Ivan is related - i.e., he
owns more than 50 percent of X Corporation - §267(b)(2).
Loss asset to minority owner
Gainacre and cash to Ivan;
Lossacre to Flo.
Gainacre – X Corporation
recognizes the $300,000 of gain on the distribution to Ivan.
Lossacre to Flo - not a
"related person" and the §336(d)(1)(A) loss limitation is not
Therefore, X Corporation may
recognize the §400,000 loss.
Loss asset held less than 5 yr.
Gainacre - +$300,000; Lossacre
Prorata distribution as tenants
Lossacre was acquired as a
contribution to X Corporation capital four years ago.
The $300,000 gain on
Gainacre is recognized.
Distribution of "disqualified
§336(d)(1)(B). Only $160,000
(40%) of the $400,000 loss on Lossacre is recognized. cont.
continued p.349 Disqualified Property
Lossacre had a value of $1
million and a basis of $800,000 at the time contributed to X corporation (i.e.,
Loss is not “built-in”;
but, the property is “disqualified property” - §336(d)(1)(B).
Property is distributed to a
The loss on the
distribution to Ivan is not recognized (i.e., 60% of the $400,000
(e) p.349 Loss asset held less than 2 yr.
Lossacre (no relationship to
X's business operations) is transferred to X by Ivan and Flo in a §351
transaction 18 months prior to the adoption of the liquidation plan when
Lossacre had a FMV of $700,000 and an adjusted basis of $800,000. FMV
declines to $400,000 FMV. If no §362(e)(2) application:
Lossacre to Flo - Loss
is $300,000 to corp, not $400,000. Partial loss is
(1) Gainacre and Lossacre
transferred to X by Ivan and (2) Flo contributes 200x.
Ivan assets: 900x basis and
800x FMV, and basis to be reduced by 100x. §362(e)(2).
§336(d)(1)(A) does not apply (distribution is prorata).
Lossacre is §336(d)(1)(B)
disqualified property. X has no loss deduction for 80% of the 300x remaining
built-in loss (240x).
§§ 362(e)(2) and 336(d)(2)
Assume (1) §362(e)(2) applied
to Ivan’s contribution to X and (2) §336(d)(2) applies to Lossacre because a
plan existed to recognize loss on that property.
recognition is permitted.
Liquidation of a Controlled
Subsidiary - §332 p.350
Liquidation of a subsidiary
into a parent corporation - assets remain held in corporate form (i.e., held by
the parent corporation).
Result to controlling
Under §332 - no gain or loss
on the receipt by the corporation of property in the complete
liquidation of an 80% or more subsidiary.
Corp. parent’s sub stock
§334(b)(1) - transferred
asset bases to parent.
George L. Riggs
Liquidation Plan Adoption
Question: What timing
for measuring the ownership of at least 80% of the stock?
Redemptions implemented by
corporation to get to the 90% share ownership level in sub.
Held: The liquidation plan was
adopted when the formal shareholder action was taken (and not adopted
When is the
liquidation plan adopted?
Result: § 332 is an
Consequences to the
§337 - nonrecognition
of gain or loss results on distributions of property by a subsidiary
to its parent corporation in a complete liquidation to which §332 applies.
§334(b)(1) - parent
corporation takes (i) a transferred basis for assets and (ii) carryover of
recapture of depreciation, etc. potential.
No acceleration of the
installment gain upon upstream distribution of notes. §453B(d).
Distributing Corporation &
Distribution of assets by the
corporation in §332 liquidation to minority shareholders triggers gain, but
not loss, to the corporation.
Loss distributions - see §336(d)(3)
deduction - to avoid directed distributions of loss property to the minority
shareholders (who do have a recognition event upon the receipt of the
Cancellation of Debt Owing from
Sub to Parent p.360
Situation: transfer of property
to satisfy debt of the subsidiary to the parent corporation.
§337(b)(1) - any transfer of
property in satisfaction of a debt is treated as a distribution and not
as a taxable event.
Objective: Precludes picking
loss property for transfer in eliminating debt, while having a tax-free
transfer of the appreciated property in the §332 liquidation. §334(b)(2).
Tax-Exempt & Foreign Parent
§337(b)(2) - nonrecognition
treatment for the liquidation of a subsidiary is not available where
the parent recipient corporation is a tax-exempt organization.
Exception: This taxability
treatment is not applicable if the property is used in the
charity’s unrelated trade or business - §511.
What impact when liquidation
distribution is made to a foreign parent corporation?
S distributes inventory
(appreciated) to I (10%) and other assets to P, Inc. (90%).
i) No recognition to P
- realized gain of $6,000 ($9,000 less $3,000) & P gets 90% of the E&P.
§334(b) transferred basis for
ii) Individual shareholder
- recognize stock gain. $800 LTCG - basis 200 and inventory of 1,000
received. §334(a) re inventory basis.
iii)Treatment to S?
Recognition for inventory.
Depreciated Property to Indiv.
Equipment to I and other assets
1) P has land and inventory
§334(b)(1) basis; plus 90
percent of 2,000 E&P (or 1,800) to P.
2) I recognizes 800 stock gain
- 1,000 FMV less 200 basis equals 800 gain; 1,000 (stepped-down) basis
to I for the equipment received.
3) S - §336(d)(3) - No
loss recognition to S on the distribution to I (& no E&P adjustment).
High Tax Basis for Sub Stock
P's basis in its S stock is
$30,000 and S also had a $30,000 basis in the land.
If S is liquidated the $30,000
basis for the stock and the loss potential for the stock disappears.
The potential tax loss on the land
is preserved in P's hands through a transferred tax basis for the land under
Loss on the equipment to I is
Avoiding §332 Applicability
How avoid §332 applicability to
enable (i) S to recognize built-in loss on the equipment and (ii) P to
recognize the loss on its S stock?
P could (i) sell S stock to get
below 80 percent requirements, or (ii) intentionally fail to meet the time
requirements of §332 by liquidating P over a period longer than the 3 year time
limit in §332(b)(3). But, §336(d)(1)(A)?
Problem 2(a) p.362
When/how to adopt plan?
Child adopts plan of complete
liquidation & distributes $2,000 cash to Uncle & remaining assets to
Mother Corp. No §332.
1) Child recognizes 3,000 on
the distribution of the installment obligation; 900 gain on the land; 900 §1245
gain on the equipment.
2) Uncle - 1,000 loss on the
3) Mother has 5,000 gain; also,
not succeeding to the $10,000 NOL of Child (less any gain).
Redemption of Uncle’s Shares
2,000 cash to Uncle for a redemption
of his 25 shares and the subsequent adoption of a plan of liquidation by
Child (into Mother).
Distribution of remaining
assets to Mother pursuant to plan of complete liquidation -when Mother owns
100 percent of the shares of Child.
recognition then occurring.
Can the $10,000 NOL be
preserved in this situation? Step transaction treatment applicable?
Debt Owing by Subsidiary
P owns all the S stock (having
$1,000 basis in the stock) and holds S bonds with a tax basis and a face value
Depreciated inventory and
Distribution of inventory in
satisfaction of $1,000 debt prior to adopting a formal plan of liquidation.
Objective of S is to recognize the $9,000 loss on the inventory.