CCH Federal Taxation Comprehensive Topics Chapter 16 Corporate Distributions in Complete Liquidations

1. CCH Federal TaxationComprehensive TopicsChapter 16Corporate Distributions in Complete Liquidations ©2005, CCH INCORPORATED 4025 W. Peterson Ave. Chicago, IL 60646-6085 800 248 3248 http://tax.cchgroup.com

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

3. 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. Complete Liquidations—Overview 4. 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. Chapter 16, Exhibit 1b CCH Federal Taxation Comprehensive Topics

5. Complete Liquidations—Overview What is the tax effect to the liquidating corporation and its former shareholders? The answer depends on whether the liquidating corporation is an at least80% owned subsidiary of a parent corporation or not. Chapter 16, Exhibit 1c CCH Federal Taxation Comprehensive Topics

6. Complete Liquidations—Overview 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. Chapter 16, Exhibit 1d CCH Federal Taxation Comprehensive Topics

7. Complete Liquidations—Overview 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. Chapter 16, Exhibit 1e CCH Federal Taxation Comprehensive Topics

8. Less Than 80% Owned Subsidiary At Least 80% Owned Subsidiary Gain or Loss: 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.] No gain or loss recognized Complete Liquidations—Effect on Liquidating Corporation  Chapter 16, Exhibit 2a CCH Federal Taxation Comprehensive Topics

9. Less Than 80% Owned Subsidiary At Least 80% Owned Subsidiary Character of gain or loss: Based on character of property. Depreciation must be recaptured under Code Secs. 1245 and 1250 N/A Liquidation Exp. Legal, etc. fully deductible Legal, etc. fully deductible Complete Liquidations—Effect on Liquidating Corporation  Chapter 16, Exhibit 2b CCH Federal Taxation Comprehensive Topics

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

11. Complete Liquidations—Effect on Shareholder Chapter 16, Exhibit 3a CCH Federal Taxation Comprehensive Topics

12. Complete Liquidations—Effect on Shareholder  Chapter 16, Exhibit 3b CCH Federal Taxation Comprehensive Topics

13. Complete Liquidations—Examples Chapter 16, Exhibit 4a CCH Federal Taxation Comprehensive Topics

14. Complete Liquidations—Examples 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. Chapter 16, Exhibit 4b CCH Federal Taxation Comprehensive Topics

15. Solutions: Assumption 1: Assumption 2: Assumption 3: 90% corporate s/h gets equipment 10% individual s/h gets inventory  $80,000 OI [100,000 – 20,000] $550,000 OI from Code Sec. 1245 depr. recapture; [850,000 – 300,000] +  $50,000 Code Sec. 1231 gain [900,000 – 300,000 – 550,000] No Gain [Code Sec. 337] No Gain [Code Sec. 337] $80,000 OI [100,000 – 20,000] No Gain [Code Sec. 337] No Gain [Code Sec. 337] Gain or loss to liquidating corporation from: Inventory: Equipment: Complete Liquidations—Examples Chapter 16, Exhibit 4c CCH Federal Taxation Comprehensive Topics

16. Solutions: Assumption 1: Assumption 2: Assumption 3: 90% corporate s/h gets equipment 10% individual s/h gets inventory $60,000 LTCG [100,000 – 40,000] Gain or loss to shareholder: $700,000 LTCG [1,000,000 – 300,000] No Gain No Gain Basis of inventory. to shareholder $100,000 $20,000 $100,000 Basis of equipment. to shareholder $900,000 $300,000 (with Code Sec. 1245 recap. potential) $300,000 (with Code Sec. 1245 recap. potential) Complete Liquidations—Examples Chapter 16, Exhibit 4d CCH Federal Taxation Comprehensive Topics