CCH Federal Taxation Comprehensive Topics Chapter 16 Corporate Distributions in Complete Liquidations ©2005, CCH INCORPORATED 4025 W. Peterson Ave. Chicago, IL

CCH Federal Taxation Comprehensive Topics 2 of 16 Chapter 16 Exhibits Chapter 16, Exhibit Contents 1. Complete Liquidations—Overview 2. Complete Liquidations—Effect on Liquidating Corporation 3. Complete Liquidations—Effect on Shareholder 4. Complete Liquidations—Examples

CCH Federal Taxation Comprehensive Topics 3 of 16 Complete Liquidations—Overview Why a complete liquidation? In a complete liquidation, shareholders surrender all of their stock in the corporation and receive their pro rata shares of any remaining assets after all creditors have been paid. Why do this? For any one of several reasons: 1. To avoid double taxation—the corporate tax on earnings, and the tax on dividends received by individual shareholders. 2. To procure cash and other assets for alternative purposes. 3. To sell the corporation’s assets to a buyer unwilling to purchase the stock. Chapter 16, Exhibit 1a

CCH Federal Taxation Comprehensive Topics 4 of To “abandon ship” — future prospects look dismal, and on- going losses cannot provide tax benefits to the corporation or its shareholders without future profits to offset. 5. To recognize capital losses at the shareholder level where, unlike corporations, they are deductible up to $3,000. Moreover, shareholders may wish to use the capital losses to offset capital gains from their personal investments. 6. To avoid corporate penalty taxes such as the personal holding company tax or the accumulated earnings tax. Complete Liquidations—Overview Chapter 16, Exhibit 1b

CCH Federal Taxation Comprehensive Topics 5 of 16 What is the tax effect to the liquidating corporation and its former shareholders? The answer depends on whether the liquidating corporation is an at least 80% owned subsidiary of a parent corporation or not. Complete Liquidations—Overview Chapter 16, Exhibit 1c

CCH Federal Taxation Comprehensive Topics 6 of 16 If liquidating corporation is NOT an at least 80% owned subsidiary— Gains/Losses are recognized: After the creditors have been paid, the liquidating corporation distributes the remaining assets to its shareholders. The distribution gets exchange treatment, just as if the shareholders had sold their stock. Complete Liquidations—Overview Chapter 16, Exhibit 1d

CCH Federal Taxation Comprehensive Topics 7 of 16 If the liquidating corporation IS an at least 80% owned subsidiary— Gains/Losses are not recognized: Code Sec. 332 provides NON-RECOGNITION of gain or loss on the distribution. The corporate shareholder must own  80% of the subsidiary’s stock, the subsidiary must be solvent, and the liquidation must be completed within 3 years of the close of the taxable year in which the liquidation began. Code Sec. 334(b)(1) provides that the parent’s basis in the assets received is the same as the subsidiary’s former basis. Complete Liquidations—Overview Chapter 16, Exhibit 1e

CCH Federal Taxation Comprehensive Topics 8 of 16 Complete Liquidations—Effect on Liquidating Corporation No gain or loss recognized Distribution of property: Market value of property distributed (or debt relief if greater) – Basis of property distributed = Gain or loss [Note: If debt relief exceeds market value of property distributed, use amount of debt relief instead of market value to compute gain or loss.] Gain or Loss: At Least 80% Owned Subsidiary Less Than 80% Owned Subsidiary Chapter 16, Exhibit 2a

CCH Federal Taxation Comprehensive Topics 9 of 16 Legal, etc. fully deductible Liquidation Exp. N/ABased on character of property. Depreciation must be recaptured under Code Secs and 1250 Character of gain or loss: At Least 80% Owned Subsidiary Less Than 80% Owned Subsidiary Complete Liquidations—Effect on Liquidating Corporation Chapter 16, Exhibit 2b

CCH Federal Taxation Comprehensive Topics 10 of 16 Complete Liquidations—Effect on Liquidating Corporation Chapter 16, Exhibit 2c Carryover. (e.g., NOL, capital loss and charitable contribution carryovers transfer to parent corporation.) Lost. (e.g., NOL, capital loss and charitable contribution carryovers from prior years are lost.) Unused carryovers: At Least 80% Owned Subsidiary Less Than 80% Owned Subsidiary

CCH Federal Taxation Comprehensive Topics 11 of 16 NOT an 80% ParentIS an 80% Parent Gain or Loss:Exchange Treatment: Market value of property received – Liability assumed – Basis of stock given up = Gain or loss No gain or loss recognized. Chapter 16, Exhibit 3a Complete Liquidations—Effect on Shareholder

CCH Federal Taxation Comprehensive Topics 12 of 16 NOT an 80% ParentIS an 80% Parent Character of gain or loss: CAPITAL, but may be ordinary loss if Sec stock N/A Basis in Property Received: Market value of property received, without being reduced by any debt assumption. Basis carries over from liquidated subsidiary. Holding Period of Property Received: Holding period for property begins on the day after receipt. Tacks on (i.e., same holding period as the HP of the assets to subsidiary.) Complete Liquidations—Effect on Shareholder Chapter 16, Exhibit 3b

CCH Federal Taxation Comprehensive Topics 13 of 16 Complete Liquidations—Examples Facts: The tax and FMV balance sheets below pertain to a corporation that is in the process of corporate liquidation: AssetsTax ABFMV Inventory$ 20,000$ 100,000 Equipment300,000900,000 Totals$320,000$1,000,000 Other Facts: 1. There are no liabilities because the creditors have been paid off. 2. The original cost of the equipment was $850, The assets above are going to be distributed to the shareholders. Chapter 16, Exhibit 4a

CCH Federal Taxation Comprehensive Topics 14 of 16 Assumption 1: The corporation is owned 100% by a single individual shareholder with a stock basis of $300,000. Assumption 2: The corporation is owned 100% by a corporate shareholder with a basis in its stock of $300,000. All the conditions of Code Sec. 332 have been met. Assumption 3: The corporation is owned 90% by a corporate shareholder (basis of $250,000) meeting the requirements of Code Sec. 332; and 10% by an individual stockholder with a stock basis of $40,000. Complete Liquidations—Examples Chapter 16, Exhibit 4b

CCH Federal Taxation Comprehensive Topics 15 of 16 Inventory: Equipment: $80,000 OI [100,000 – 20,000] No Gain [Code Sec. 337] No Gain [Code Sec. 337] No Gain [Code Sec. 337] No Gain [Code Sec. 337] $80,000 OI [100,000 – 20,000] $550,000 OI from Code Sec depr. recapture; [850,000 – 300,000]  $50,000 Code Sec gain [900,000 – 300,000 – 550,000] Gain or loss to liquidating corporation from: 10% individual s/h gets inventory 90% corporate s/h gets equipment Assumption 3:Assumption 2:Assumption 1: Solutions: Complete Liquidations—Examples Chapter 16, Exhibit 4c

CCH Federal Taxation Comprehensive Topics 16 of 16 $60,000 LTCG [100,000 – 40,000] $300,000 (with Code Sec recap. potential) $300,000 (with Code Sec recap. potential) $900,000Basis of equipment. to shareholder $100,000$20,000$100,000Basis of inventory. to shareholder No Gain $700,000 LTCG [1,000,000 – 300,000] Gain or loss to shareholder: 10% individual s/h gets inventory 90% corporate s/h gets equipment Assumption 3:Assumption 2:Assumption 1: Solutions: Complete Liquidations—Examples Chapter 16, Exhibit 4d