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Tax 4022/5022 Federal Income Tax II Chapter 20

Tax 4022/5022 Federal Income Tax II Chapter 20. Dr. Robert R. Oliva Professor and Chairperson Department of Accounting University of Arkansas at Little Rock. CORPORATE LIQUIDATIONS. I. Liquidating a free-standing corporation II. Liquidating a subsidiary.

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Tax 4022/5022 Federal Income Tax II Chapter 20

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  1. Tax 4022/5022 Federal Income Tax II Chapter 20 Dr. Robert R. Oliva Professor and Chairperson Department of Accounting University of Arkansas at Little Rock

  2. CORPORATE LIQUIDATIONS • I. Liquidating a free-standing corporation • II. Liquidating a subsidiary

  3. I. Liquidating a free-standing corporation

  4. LIQUIDATIONS: IRC 331/336 • Was it a liquidation or something else? • If a liquidation, • General rule: IRC 331/336 • One exception [IRC 336(d)(1)]: • Dont recognize loss to distributing corp if recipient is • Related and • Distributing • Non-prorata/any property • Pro-rata/disqualified property • One special rule [IRC 336(d)(2)]: • Distributions with tax avoidance

  5. Was it a liquidation? • Based on interpretations. • No specific plan of liquidation requirement. • But better to have a plan because • Is it a 331 or a 301 distribution? • Necessary for recogniton of loss.

  6. If a liquidation, what is the tax effect? • Effect on recipients: IRC 331 • “Amounts received by a shareholder in a distribution in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock” • Effects on corporation: IRC 336 • Except as otherwise provided in this section . . . gain or loss shall be recognized to a liquidating corporation on the distribution of property in complete liquidation as if such property was sold to the distributee at its fair market value.

  7. DISTINGUISH: Corporate effect: IRC 336 v. IRC 311(a) and (b) • IRC 311: No gain or loss shall be recognized by corporate distributor in IRC 301 property distributions. • Exception: recognize gain if distributing appreciated property. • IRC 336: Recognize gain or loss.

  8. EFFECT OF DISTRIBUTING PROPERTY SUBJECT TO LIABILITIES ON FMV • IRC 336(b) • “FMV” = NOT LESS THAN LIABILITY

  9. THEREFORE, BARRING EXCEPTIONS, TREAT AS A SALE • IRC 1001 TRANSACTION AS TO BOTH PARTIES • CAPITAL GAIN/CAPITAL LOSS RECOGNITION

  10. EXCEPTION AND SPECIAL RULE • AS TO RECIPIENTS: NONE • AS TO LIQUIDATING CORPORATION: • EXCEPTION: RELATED PARTY • NON-PRORATA/ANY PROPERTY • PRO-RATA/DISQUALIFIED PROPERTY • SPECIAL RULE: TAX AVOIDANCE

  11. EFFECT OF IRC 267(a)(1): FIRST SENTENCE • “. . . NO DEDUCTION SHALL BE ALLOWED IN RESPECT OF ANY LOSS FROM THE SALE OF EXCHANGE OF PROPERTY . . . BETWEEN PERSONS SPECIFIED IN ANY OF THE PARAGRAPHS IN SUBSECTION (b) . . . .”

  12. EFFECT OF IRC 267(a)(1): SECOND SENTENCE • THE PRECEDING SENTENCE SHALL NOT APPLY TO ANY LOSS OF THE DISTRIBUTIING CORPORATION (OR THE DISTRIBUTEE) IN THE CASE OF A DISTRIBUTION IN COMPLETE LIQUIDATION • DOES THAT MEAN THAT IRC 267 DOES NOT APPLY TO LIQUIDATING DISTRIBUTIONS?

  13. EFFECT OF IRC 267(a)(1)’S SECOND SENTENCE ON RECIPIENT • IRC 331 CONTAINS NO LIMITATIONS OR REFERENCE TO IRC 267. • THUS: 2ND SENTENCE HAS CRITICAL EFFECT, E.G., AN EXCEPTION TO THE EXCEPTION. • ALLOWS RECIPIENTS TO RECOGNIZE LOSS EVEN IF RELATED PARTIES.

  14. EFFECT OF IRC 267(a)(1)’S SECOND SENTENCE ON LIQUIDATING CORPORATION • IF IRC 336 DID NOT CONTAIN ANY REFERENCE TO IRC 267, THEN IRC 267(a)(1) WOULD NOT PREVENT RECOGNITON OF LOSS BY THE LIQUIDATING CORPORATION. • HOWEVER, • EXCEPTION: IRC 336(d)(1) • SPECIAL RULE: IRC 336(d)(2)

  15. EXCEPTION [IRC 336(d)(1)]: NO LOSS SHALL BE RECOGNIZED • TO A LIQUIDATING CORPORATION ON THE DISTRIBUTION . . . TO A RELATED PERSON ( WITHIN THE MEANING OF SECTION 267) • IF SUCH DISTRIBUTION IS NOT PRO RATA OR (EVEN IF PRO-RATA), SUCH PROPERTY IS DISQUALIFIED PROPERTY

  16. WHEN TO RECOGNIZE LOSS IF RELATED RECIPIENTS? • PRO RATA DISTRIBUTION AND THE DISTRIBUTION IS OTHER THAN “DISQUALIFIED PROPERTY”

  17. SUMMARY OF 267(a)/336(d) RELATIONSHIP: • IRC 267 1ST SENTENCE: NO LOSS • IRC 267(a)(1)’S 2ND SENTENCE: BUT OK TO RECOGNIZE LOSS IN LIQUIDATION • IRC 336(d)(1), BY ITS OWN TERMS, NO LOSS RECOGNIZED IF RECIPIENT IS RELATED AND DISTRIBUTION IS • NON-PRORATA / ANY PROPERTY OR • PRO-RATA / “DISQUALIFIED PROPERTY”

  18. HENCE: FOR THIS EXCEPTION NEED TO KNOW • IRC 267 • DEFINITION OF PRO-RATA • DEFINITION OF “DISQUALIFIED PROPERTY”

  19. WHO’S RELATED? > 50% OWNERSHIP • CORPORATIONS AND INDIVIDUAL SHAREHOLDERS • CORPORATIONS IN CONTROLLED GROUP • CORPORATIONS AND TRUST SHAREHOLDERS • CORPORATION AND PARTNERSHIP SHAREHOLDERS • AN S AND A C CORPORATION

  20. INDIVIDUALS AND THEIR CORPORATIONS [IRC 267(b)(2)] • MORE THAN 50% IN VALUE OF THE OUTSTANDING STOCK OF WHICH IS OWNED, DIRECTLY OR INDIRECTLY, BY OR FOR SUCH AN INDIVIDUAL.

  21. TWO CORPORATIONS IN CONTROLLED GROUP [IRC 267(b)(3)] • MORE THAN 50% OWNERSHIP IN PARENT/SUB GROUP OR BROTHER/SISTER GROUP • SEE IRC 267(f) AND IRC 1563(b) • IRC 1563 HAS ITS OWN SET OF ATRIBUTION RULES

  22. FIDUCIARY OF TRUST AND CORPORATION [IRC 267(b)(8)] • MORE THAN 50% IN VALUE OF THE OUTSTANDING STOCK OF WHICH • IS OWNED, DIRECTLY OR INDIRECTLY, BY OR FOR THE TRUST OR BY OR FOR A PERSON WHO IS A GRANTOR OF THE TRUST.

  23. CORPORATION AND PARTNERSHIP [IRC 267(b)(10)] • IF THE SAME PERSONS OWN • MORE THAN 50% IN VALUE OF THE OUTSTANDING STOCK OF THE CORPORATION AND MORE THAN 50% OF THE CAPITAL INTEREST, OR THE PROFITS INTEREST, IN THE PARTNERSHIP.

  24. AN S AND A C CORPORATION [IRC 267(b)(12)] • IF THE SAME PERSONS OWN • MORE THAN 50% IN VALUE OF THE OUTSTANDING STOCK OF EACH CORPORATION.

  25. NOTE • “267 RELATED” IS DEFINED BY “>50%”. • BUT IRC 318 ATTRIBUTION PERMITTED FROM/TO CORPORATIONS WHEN “50% OR MORE” OWNERSHIP

  26. IRC 267(c): CONSTRUCTIVE OWNERSHIP • FOR PURPOSES OF DETERMINING, IN APPLYING SUBSECTION (b), THE OWNERSHIP OF STOCK . . . CONSIDER IRC 267(c)(1)-(5): • ATTRIBUTION FROM ENTITIES • FAMILY ATTRIBUTION • PARTNER ATTRIBUTION

  27. IRC 267(c)(1): ATTRIBUTION FROM ENTITIES (% AFE) • STOCK OWNED, DIRECTLY OR INDIRECTLY, BY OR FOR A CORP, PARTNERSHIP, ESTATE, OR TRUST SHALL BE CONSIDERED AS BEING OWNED PROPORTIONATELY BY OR FOR ITS SHAREHOLDERS, PARTNERS, OR BENEFICIARIES.

  28. NOTE: UNLIKE IRC 318 • NO % REQUIREMENT (IRC 318 requires “50% or more” ownership to get attribution from a corporation) • NO “ATE ALL” (IRC 318 contains an attribution to entities) • BUT B/C OF 267(c)(1), AS SHDRS, P’S, OR BENES COULD BE ENTITIES, THERE COULD BE ENTITIES RECEIVING ATTRIBUTION.

  29. IRC 267(c)(2): FAMILY ATTRIBUTION • AN INDIVIDUAL SHALL BE CONSIDERD AS OWNING THE STOCK OWNED, DIRECTLY OR INDIRECTLY, BY OR FOR HIS FAMILY • IRC 267(c)(4): THE FAMILY OF AN INDIVIDUAL SHALL INCLUDE ONLY HIS BROTHERS AND SISTERS (. . .WHOLE OR HALF BLOOD), SPOUSE, ANSCESTORS, AND LINEAL DESCENDANTS.

  30. NOTE: UNLIKE 318, “FAMILY’ MEANS: • ALL THE WAY UP (not 1 up) • ALL THE WAY DOWN (not 2 down) • ALL THE WAY TO THE SIDES (only spouses permitted in IRC 318)

  31. IRC 267(c)(3): PARTNER ATTRIBUTION • AN INDIVIDUAL OWNING . . . ANY STOCK IN A CORPORATION SHALL BE CONSIDERED AS OWNING THE STOCK OWNED, DIRECTLY OR INDIRECTLY, BY OR FOR HIS PARTNER. • DO NOT ATTRIBUTE PARTNER’S FAMILY ATTRIBUTION STOCK • 318 HAS NO PARTNER ATTRIBUTION

  32. IRC 267(c)(5): REATTRIBUTIONS • STOCK ATTRIBUTED FROM AN ENTITY TO ENTITIES, FAMILY, AND PARTNERS IS REATTRIBUTABLE TO OTHERS. • INDIVIDUALS RECEIVING ATTRIBUTION FROM ENTITIES MAY REATTRIBUTE • BUT INDIVIDUALS RECEIVING ATTRIBUTION FROM A FAMILY MEMBER OR A PARTNER CANNOT REATTRIBUTE TO ANYONE.

  33. PRO-RATA DEFINITION: • DISTRIBUTION MUST BE ROPORTIONATE TO STOCK OWNERSHIP

  34. EXAMPLE 2: PRO-RATA DISTRIBUTION • CORP OWNED BY A (40%) AND BY B (60%) • CORP HAS TWO ASSETS:ASSET 1 W/FMV $40, ASSET 2 W/ FMV $60 • PRORATA MEANS • A GETS 40% OF ASSET 1 AND 40% OF ASSET 2 • B GET 60% OF ASET 1 AND 60% OF ASSET 2.

  35. DISQUALIFIED PROPERTY: IRC 336(d)(1)(B) • DEFINED BY HOW AND WHEN ACQUIRED • HOW: IRC 351 OR CONTRIBUTION TO CAPITAL • WHEN: WITHIN FIVE YEAR PERIOD ENDING ON DISTRIBUITON DATE • LOOKBACK 5 YEARS FROM DATE OF DISTRIBUTION

  36. EXAMPLE 3 • DAY1/YR1: B SOLE SHDR OF X, TFRS CASH AND PTY W/120 FMV/90AB. • DAY1/YR4: X LIQUIDATES WHEN PTY FMV=70: 70-90=(20) NOT RECOGNIZED. B IS RELATED/PTY 2 IS “DISQUALIFIED”

  37. SOLUTION • DAY1/YR2: B TRFR PTY TO NEW Y CORP • DAY1/YR3: MERGE Y AND X • DAY1/YR4: X LIQUIDATES. • PTY NOT ACQUIRED IN IRC 351 BY THE LIQUIDATING CORP. • IT WAS ACQUIRED BY THE MERGING CORPORATION.

  38. EXAMPLE 4 • Y CORP HAS CASH 4K AND PTY 12FMV/40AB (NOT DISQUALIFIED). OWNED 75% BY B AND 25% BY C. • IF PTY DISTRIBUTED PRO-RATA, CORP RECOGNIZES LOSS. • PTY IS JOINTLY OWNED, BUT B COULD PURCHASE C’S 25% AFTER LIQUIDATION. C RECOGNIZES NO GAIN B/C AB = FMV.

  39. COLLAPSIBILITY? • IF COLLAPSED: NON-PRORATA AND Y CORP’S LOSS DISALLOWED. • HOWEVER SHOULD BE RESPECTED IF C HAD NO PRE-ARRANGED OBLIGATION TO SELL TO B. AMERICAN BANTAM CAR CO.

  40. SPECIAL RULE: IRC 336(d)(2) • APPLIES TO DISTRIBUTIONS TO RELATED AND NONRELATED PARTIES • DEFINED BY HOW AND WHEN ACQUIRED

  41. THE “HOW”: • IRC 351 OR CONTRIBUTION TO CAPITAL AND • ACQUISITION’S PRINCIPAL PURPOSE WAS TO RECOGNIZE LOSS • FOR PRACTICAL PURPOSES: ACQUISITIONS OF LOSS PROPERTIES, E.G., AB > FMV.

  42. THE “WHEN”: • TAINT EXISTS IF PROPERTY ACQUIRED WITHIN THE 2 YEARS ENDING ON THE ADOPTION OF PLAN OF LIQUIDATION • LOOKBACK 2 YEARS FROM PLAN’S ADOPTION • LEGISLATIVE INTENT: APPLY RARELY IF ACQUIRED LONGER THAN 2 YEARS FROM ADOPTION.

  43. EFFECT OF SPECIAL RULE: IRC 336(d)(2)(A) • REDUCE AB OF PROPERTY BY THE AMOUNT OF THE BUILT-IN LOSS AT TIME OF ACQUISITION.

  44. EXAMPLE 5 • Z OWNS PTY FMV 15/AB 20, CONTRIBUTED 1 YEAR AGO. • THUS: AB = 20 - 5 AB EXCESS OVER FMV = 15 • Z LIQ. PTY 1 TO UNRELATED PARTY WHEN FMV=10. • RESULT: 10 FMV -15 AB = (5 ) RECOGNIZED LOSS

  45. EXAMPLE 6 • SAME AS 3. BUT NOW LIQ PTY 1 TO RELATED PARTY. • NO LOSS RECOGNIZED. SEE B/E 10-30. IF 336(d)(1) AND (2) OVERLAP, 336(d)(1) SHOULD APPLY TO DENY ALL LOSS.

  46. EXAMPLE 7 • W CORP OWNED 70% BY A AND 30% BY B. W OWNS PTY 1, FMV 15/AB30 AND PTY 2, FMV 7.5/AB 3. PTY 1 CONTRIBUTED LAST YR WHEN FMV WAS 27. • W LIQ PRO-RATA: 70% OF PTY 1 AND PTY 2 TO A; 30% OF PTY 1 AND PTY 2 TO B.

  47. TAX EFFECT TO W? • PTY 1: 336(d)(2): NEED TO ADJUST AB: 30 - 3 AB EXCESS OVER FMV = 27 AB. • THUS 15 FMV- 27 AB = (12) LOSS REALIZED. • AS A IS RELATED AND PTY 1 IS “DISQUALIFIED”. 70% OF LOSS (8.4) IS NOT RECOGNIZED. • WHAT ABOUT B?

  48. B IS NOT RELATED, BUT 336(d)(2) APPLIES. • AS AB ADJUSTED TO 27, 30% (15 FMV - 27 AB) = (3.6) LOSS RECOGNIZED • THUS: OF THE 12 LOSS REALIZED, ONLY 3.6 IS RECOGNIZED

  49. NOTE: • 336(d)(1): • APPLIES ONLY TO RELATED PARTIES • DISALLOWS ALL LOSSES: PRE AND POST ACQUISITION • 336(d)(2): • APPLIES TO DISTRIBUTIONS TO BOTH RELATED AND NONRELATED PARTIES • ALLOWS POST-ACQUISITION LOSSES

  50. FILING REQUIREMENTS • ATTACHED TO RETURN: MINUTES @ PLAN ADOPTION AND INFO ABOUT PROPERTIES • FORM 966: TO IRS WITHIN 30 DAYS OF ADOPTION • FORM 109-DIV: TO SHAREHOLDERS BY 1/31 YEAR AFTER LIQ. • FORM 1096: TO IRS BY 2/28 YEAR AFTER LIQ.

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