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Chapter 6 Corporate Liquidations A) Sec. 331(a) Distributions in Complete Liquidation 1) Effect of Liquidation on SH1 a) General rule provides for sale or exchange treatment if distribution is in full payment for stock [331(a)]. (i) Shareholders treated as having sold their stock to liquidating corporation in exchange for the assets distributed. Liabilities assumed by the shareholder reduce the shareholders amount realized. See Item 2)c) Note 2 below regarding treatment of liabilities in excess of FMV. (ii) Difference b/t FMV of property distributed and basis of stock surrendered is gain or loss. Usually capital2. Burden of proof regarding basis of stock is on tp. If tp cannot prove basis of stock, basis assumed to be zero and entire dist. is capital gain. b) The basis of each property received is stepped up or stepped down to the propertys FMV on the liquidation date. See Item 2)c) Note 1 below regarding shareholders basis when liabilities assumed exceed the propertys FMV. c) The holding period for properties received in liquidation begins on the day after the liquidating date.

If a parent liquidates a controlled subsidiary, the parent corporation (the shareholder) recognizes no gain or loss. In addition, the bases and holding periods of the subsidiarys assets carry over to the parent. (SEE BELOW) 2 Loss recognized by an individual shareholder on qualified 1244 stock is ordinary subject to certain limitations. Further, 165(g)(3) allows corporate shareholders to recognize ordinary loss on worthlessness of a controlled subsidiarys stock.

2) Effect of liquidation on the liquidating corporation3 a) Tax attributes of the corporation, such as NOL carryovers and E&P, disappear when the corporation is liquidated. b) Sec. 336(a) A liquidating corporation recognizes gain AND loss on distribution of property in complete liquidation. Property treated as though sold at FMV. (This is unlike nonliquidating distributions, where gains are required to be recognized but losses are not allowed). c) Sec. 336(b) If sh assumes liab. in liquidating distribution, the FMV for purposes of calculating gain/loss cannot be less than the value of the liab. We will follow the same as rules for nonliquidating distribution. NOTE 1: Treatment at the shareholder level is not completely clear (as I mentioned before). Sec. 334(a) requires the shareholder to take a basis in the distributed property equal to its FMV. Does the shareholder take a basis equal to the true FMV or the liability amount that exceeds the FMV? Some commentators suggest a strict interpretation of the Code, which would give the shareholder a basis equal to the true FMV, rather than the greater liability basis, produces an illogical result.4 For the purposes of this class, we will assume in all of our problems that the shareholder assumes a basis equal to the greater liability amount when 336(b) applies. Note 2: Also, given that the liability exceeds the FMV of the distributed property, the shareholders amount realized should be zero. Thus if the amount realized on the sale is zero the result is a capital loss to the sh equal to shs stock basis. 3) Exceptions to Gain or Loss Recognition Rule
If the liquidating corporation is an 80%-controlled subsidiary of the parent corporation, the liquidating corporation recognizes no gain or loss. In this case the subsidiarys tax attributes carry over to the parent. (SEE BELOW) 4 For a detailed discussion, see Randall and Stewart, Corporate Distributions: Handling Liabilities in Excess of FMV of Property Remains Unresolved, The Journal of Corporate Taxation, Spring 1992, pp. 55-64.
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a) Antistuffing Rules -- Losses on Distributions to Related Parties 336(d)(1) Related party (>50%) losses are not allowed if: distribution is not pro-rata or distribution is of disqualified prop. Pro-rata -> Each sh receives his/her ratable share of each asset Disqualified property -> property acquired by corporation in 351 transaction or as contribution to capital in 5 year period before distribution. b) Built-in losses -- 336(d)(2) provides that if loss property is transferred to a liquidating corporation shortly before liquidation in 351 transaction or as contribution to capital as part of plan to recognize loss on distribution or sale. (i) No loss allowed. (ii) Only applies to loss property. (iii) Losses disallowed limited to built-in loss. Holding losses allowed. (iv) Plan to recognize loss will be presumed if contribution was w/in 2 years of liquidation. (v) Two years is not a fail safe. If built-in loss proper (vi) Presumption can be rebutted by business purpose. (vii) Also, loss disallowance applies only to built-in losses. (viii) Loss is disallowed for related and unrelated parties. This provision prevents a sh from transferring loss property into a corporation to reduce or eliminate the gain the liquidating corporation otherwise would have recognized from the distribution of other appreciated property. The basis of the contributed property for loss purposes equals its adjusted basis on the liquidating corporations books reduced (but not below zero) by the excess (if any) of the propertys adjusted basis over its FMV immediately after its acquisition. No adjustment occurs to the contributed propertys adjusted basis when determining the corporations recognized gain.

Example: Tony makes a capital contribution of a widget maker having a $1,000 adjusted basis and a $100 FMV to Patel Corporation in exchange for additional stock on April10, 2002. At the same time Tony contributed another property with a $900 AB and a $2,000 FMV. On August 3, 2003, Patel Corporation adopts a plan of liquidation. During the time period between April 10, 2003 and the date the plan of liquidation was adopted, the widget maker is not used in Patels trade or business. Liquidation occurs on December 10, 2003, and Patel distributes the widget maker and a second property that has a $2,500 FMV and a $900 adjusted basis. What are the tax results?

4) Sec. 162 allows deduction of liquidation expenses as business expenses B) Liquidations of a Controlled Subsidiary a) 332(a) Exception to general rule of Sec. 331 -- no gain or loss recognized by a PARENT corp. on receipt of property dist. in complete liquidation of another corporation (its subsidiary). (i) Sec. 332 applies only to the parent corporation. Other shareholders owning a minority interest are taxed under the general liquidation rules of 331. When 332 applies to the parent corporation, 337 permits the liquidating corporation to recognize no gains or losses on the assets distributed to the parent corporation. The liquidating corporation recognizes gains (but not losses) on distributions made to shareholders holding a minority

(ii)

interest. b) Purpose is to allow corporate group to simplify its corporate structure without any adverse tax effects. 1) Requirements a) Parent must own => 80% of voting stock of sub and => 80% of total value of subs stock. b) There must be complete cancellation or redemption of all the stock of the sub in accordance with a plan. c) Sub must dist. all prop. in complete cancellation of stock w/in taxable year or 3 taxable years if plan. Sec. 332 is mandatory if these requirements are met. If one or more of the above conditions is not met, the parent corporation is taxed under the general liquidation rules above. 2) Effect of Liquidation on the Shareholders a) Recognition of Gain or Loss (i) Parent -- Sec. 332(a) nonrecognition rule applies only to a parent corporation that receives a liquidating distribution from a solvent subsidiary. Sec. 332(a) does not apply to a parent corporation that receives a liquidating distribution from an insolvent subsidiary, to minority shareholders or to a parent corporation that receives a payment to satisfy the subsidiarys indebtedness to the parent. Insolvent Sub -- 332 does not apply if the sub is insolvent b/c the parent does not receive the distribution in exchange for its stock investment. Insolvency = Liabilities > FMV of Assets No assets available for distribution to owners and parent s/n

receive any payment. Reg. 332-2(b) requires the parent to receive at least partial payment for its stock to qualify for nonrecognition under 332.5 (ii) Minority Shareholders -- Liquidating distributions to minority shareholders are taxed under 331 liquidation rules (as above). Minority SH recognize gain or loss (generally capital) upon the redemption of their stock in the subsidiary corporation. b) Basis of Property Received -- The parent corporations basis for property received in the liquidating distribution is the same as the subsidiary corporations basis prior to the distribution [334(b)(1)]. The parent corporations basis for its stock investment in the sub is ignored in determining the basis for the distributed property and disappears once the parent surrenders its stock. As above, property received by minority shareholders takes a basis equal to its FMV. 3) Effects of Liquidating on the Subsidiary Corporation a) Sec. 337 liquidating corporation does not recognize gain or loss on liquidating distribution of property to parent (80% owner) if 332 applies. b) If 332 applies so that parent doesnt recognize any gain/loss on liquidation of subsidiary, the parent corporation generally inherits all of the tax attributes of the sub. (i) (ii) The subs E&P account balance is added to that of the parent corporation. (Sec. 381(a) and (c)(2)) Property acquired by parent from sub has the same basis that it had in the hands of the sub (Sec. 334(b)(1)). Depreciation recapture carries over to parent.

If the sub is insolvent, the special worthless security rule of 165(g)(3) for affiliated corporations and the bad debt rules of 166 permit the parent to recognize ordinary loss w.r.t. its investment in the subs stock or debt.

(iii) Parent succeeds to other tax characteristics of sub including subs NOL, capital loss carryovers. c) The Sec. 337(a) nonrecognition rule applies only to distributions to the parent corporation. Liquidating distributions to minority shareholders are not eligible for nonrecognition. Liquidating corporation must recognize under 336(a) when it distributes property to minority shareholders. Losses are not recognized on distributions made to minority shareholders [336(d)(3)]. Thus, liquidating distributions to minority shareholders are treated the same as nonliquidating distributions. 4) Indebtedness of liquidated sub to parent. a) If sub is indebted to parent, some part of the property distributed to the parent is in satisfaction of the subs debt. 337(b)(1) if sub owed debt to parent, dist. still treated under Sec. 332(a) for the subsidiary. b) Reg. Sec. 1.332-7 parent still recognizes gain or loss on settlement of debt even though 332 applies. c) Sec. 332 applies only to prop. received by parent corp. in its role as a shareholder. It does not apply to property received in satisfaction of debt owed to the parent corp. d) If property received by parent in satisfaction of debt owed to it by sub, the parent must recognize gain or loss on the transaction, whether it was part of a liquidating distribution or not. e) To avoid recognition of gain or loss, parent may be able to contribute debt to sub prior to liquidation. If done, the sub is treated though it satisfied the debt to parent with an amount of money equal to parents basis in the indebtedness (Sec. 108(e)(6)).

L) 338 election -- Stock Purchases Treated as Asset Acquisitions (TEFRA 1982) a) When a corp acquires a controlling interest (80 percent) in another corp., the acquisition cost of the stock will reflect the FMV of the subsidiarys assets (including goodwill). b) Sec. 338 allows an acquiring corp. to purchase stock of target corp and either 1) retain the corps basis for its assets, or 2) make a special election to adjust the basis of the assets to the amount paid for the corporation stock. c) Corp. wants to acquire business conducted by a second corp. can do so in one of three ways: (i) Purchase target corps stock, liquidate target or continue to operate target as sub. (ii) Purchase target corps assets. Target may be liquidated. (iii) Purchase target corps stock and elect under Sec. 338 to have the purchase treated as an acquisition of targets assets. Target may be liquidated or continue to operate as a sub. d) 338(a) If purchasing corp makes valid election, then in the case of any qualified stock purchase, the target is treated as though (i) target sold all assets at FMV at acquistion data, AND (ii) target treated as new corp on day after e) Valid election -- 15th day of the 9th month following the month the acquisition was made. Form 8023 or statement of election. f) Qualified stock purchase acquiring corp purchases at least 80% of total value of all shares of stock g) The target corp is treated as having sold all of its assets at the close of the acquisition date at their FMV in single transaction. Target recognizes G/L on the deemed sale of its assets on final TR. h) Target becomes a member of purchasing corps affiliated group the day after acquistion. So gain not on purchases consolidated TR.

i) Target corp / deemed purchasing corp has basis in assets equal to FMV j) Total basis in assets is derived from the amount paid by purchasing corporation for targets stock. k) Holding period starts anew.