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

I. Liquidating a free-standing
corporation
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
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.

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.

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.
EFFECT OF DISTRIBUTING
PROPERTY SUBJECT TO
LIABILITIES ON FMV
IRC 336(b)
 “FMV” = NOT LESS THAN LIABILITY

THEREFORE, BARRING
EXCEPTIONS, TREAT AS A
SALE
IRC 1001 TRANSACTION AS TO BOTH
PARTIES
 CAPITAL GAIN/CAPITAL LOSS
RECOGNITION

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
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) . . .
.”
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?

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.

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)
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


WHEN TO RECOGNIZE
LOSS IF RELATED
RECIPIENTS?
PRO RATA DISTRIBUTION AND THE
DISTRIBUTION IS OTHER THAN
“DISQUALIFIED PROPERTY”
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”
HENCE: FOR THIS
EXCEPTION NEED TO
KNOW
IRC 267
 DEFINITION OF PRO-RATA
 DEFINITION OF “DISQUALIFIED
PROPERTY”

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


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.
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
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.

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.

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.

NOTE
“267 RELATED” IS DEFINED BY
“>50%”.
 BUT IRC 318 ATTRIBUTION
PERMITTED FROM/TO
CORPORATIONS WHEN “50% OR
MORE” OWNERSHIP

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
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.
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.
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

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)

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

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
PRO-RATA DEFINITION:

DISTRIBUTION MUST BE
ROPORTIONATE TO STOCK
OWNERSHIP
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.
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
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”

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.

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.

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.

SPECIAL RULE: IRC
336(d)(2)
APPLIES TO DISTRIBUTIONS TO
RELATED AND NONRELATED PARTIES
 DEFINED BY HOW AND WHEN
ACQUIRED

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.
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.

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.
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

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.

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.

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?

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

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
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.

CONCLUSION
LIQUIDATIONS TREATED AS SALES.
 ISSUE: WHETHER CORPORATION CAN
RECOGNIZE LOSS

– DISTRIBUTION IS NON-PRORATA (ANY
PROPERTY)
– DISTRIBUTION PRO-RATA +
DISQUALIFIED PROPERTY
– TAX AVOIDANCE, E.G., B/I LOSS PTY W/I
2 YRS OF PLAN ADOPTION.
II. SUBSIDIARY
LIQUIDATIONS

IRC 332/337
Introduction
Definition of a liquidation
 Tax effect

DEFINITION OF “COMPLETE
LIQUIDATION”
Treas. Reg. 1.332-2(c)(1) and
(2)

one of a series . . . plan of liquidation . . .
status of liquidation . . . completed when
liquidating corporation and receiver or
trustees in liquidation are finally divested of
all the property . . .
Treas. Reg. 1.332-2(c)(2)
cont.

Status of liquidation exists when the
corporation ceases to be a going concern
and its activities are merely for the purpose
of winding up its affairs, paying its debts,
and distributing any remaining balance to
its shareholders.
Treas. Reg. 1.332-2(c)(2)
cont.

A liquidation may be completed prior to the
actual dissolution of the liquidating
corporation. However, legal dissolution is
not required. Nor will the mere retention of
a nominal amount of assets for the sole
purpose of preserving the corporation’s
legal existence disqualify it.
Treas. Reg. 1.332-2(d)

If a transaction constitutes a distribution in
complete liquidation within the meaning of
the IRC. . . it is not material that it is
otherwise described under local law.
TAX EFFECT
Tax effect of corporate
liquidation: Subchapter C; Part
II

Subpart A: Effect on recipients: IRC 331;
332; 334
– IRC 331:
In other than IRC 332 liquidations: Applies to
majority and minority shareholders
 In IRC 332 liquidations: Applies to minority
shareholders

– IRC 332: Liquidation of subsidiary

Subpart B: Effect on corporation : IRC 336;
337; 338
Tax effect on recipients
(parent): IRC 332(a)
“No gain or loss shall be recognized on the
receipt by a (parent) corporation of property
distributed in complete liquidation of
another (its subsidiary) corporation.”
 Rationale: Liquidation of a subsidiary
represents a change of form and not a
change in economic investment.

Elements in IRC 332(b)
Ownership
 Timing of ownership
 Complete cancellation or redemption of
stock
 Timing of distribution

Ownership

80% direct (not constructive) ownership:
– > 80% of combined voting power, and
– > 80% total value of all stock

Except nonvoting, nonparticipating
preferred
Timing (length) of ownership:
From: Day plan was adopted
 To: Last liquidating distribution

Complete cancellation or
redemption of stock
Legal dissolution of subsidiary is not
required.
 OK to retain minimal amount to protect
legal existence and preserve corporate
charter

Timing of distribution: Two
alternatives
One year liquidation
 Multiyear liquidation

One year liquidation

Liquidating distribution completed within
one (1) of the subsidiary’s taxable year.
– Shareholders’ resolution will suffice.

It is considered a “plan of liquidation”: IRC
332(b)(2)
– Liquidation does not have to take place in year
of resolution.
Multiyear liquidation

Liquidating distributions to be completed in
> 1 of the subsidiary’s taxable year
– Formal plan must be adopted
– Distributions completed within 3 taxable years
after the close of the taxable year of the first
distribution.

Note: Distribution will not be considered a
“liquidating distribution” if there is a failure
to complete liquidation timely or a failure to
meet the ownership requirements.
Tax Planning
Like IRC 351, IRC 332 is not an elective
section: You either fall “within” or
“without”.
 Hence, like IRC 351, to avoid IRC 332, you
can plan

– to fail one of the requirements, e.g., get below
80%.
– to make sure you meet the requirements, e.g.,
get to 80%.
Issues
Insolvent subsidiary
 Subsidiary debt (not classified as a security)
 Minority shareholders

Insolvent subsidiary: IRC
165(g)(3)
As parent gets no “property” for its stock,
IRC 332 does not apply.
 Instead treat as loss from worthless
securities [IRC 165(g)].

– Capital or Ordinary?
Generally capital, but ordinary
loss treatment if falls under
IRC 165(g)(3)

Parent has IRC 351 “control”
= > 80% of aggregate voting class and power and
 => 80% of each non-voting class;

– o/t nonvoting stock limited and preferred as to dividends

“Active” type subsidiary for all taxable
years

> 90% of gross receipts from non-passive income
Subsidiary debt [o/t “security”
under IRC 165(g)(2)]
Debt considered a “security” if it has
interest coupons or issued in registered
form.
 Thus, loss from receipt of “debt” in bearer
form and without interest coupons in a
liquidating distribution is deductible as a
business bad debt.

Effect on liquidating
corporation:
IRC 336
 IRC 337

IRC 336

Except as otherwise provided in this section
or section 337, 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.
Therefore, barring exceptions,
treat liquidating distributions
as a sale of property
Exceptions
Various, within IRC 336, covered in Tax
6105.
 IRC 337

IRC 337
No gain or loss shall be recognized to the
liquidating corporation on the distribution to
the 80-percent (parent) distributee of any
property in complete liquidation to which
section 332 applies.
 No depreciation recapture by subsidiary

– AB c/o to parent corporation
Loss distributions to minority
shareholders

While minority shareholders may recognize
a loss in the receipt of a liquidating
corporation, IRC 336(d)(3) prohibits
recognition of loss by the liquidating
subsidiary in a IRC 332 liquidation.
Issue: Liquidating distribution
is “debt”

Indebtedness of one of the parties is
distributed as “property” in a liquidating
distribution
– Parent’s indebtedness to subsidiary (subsidiary
is the creditor).
– Subsidiary’s indebtedness to parent (subsidiary
is the debtor; parent is the creditor)
Parent’s indebtedness to
subsidiary.
– Is parent’s receipt of its own note to the
subsidiary produce gain from discharge of
indebtedness?
– Answer: No, because debt is “property”
received in an IRC 332 liquidation.
Subsidiary’s indebtedness to
parent
IRC 337(b)
 Sub distributes appreciated property in
cancellation of debt to parent.

– Treat as “property” transferred in a liquidating
distribution.
– Sub does not recognize gain on appreciated
property
– Parent takes c/o AB
Tax Planning for the
subsidiary
Distribute appreciated property to parent
corporation
 Distribute cash to minority shareholders
 But sell loss property to unrelated taxpayers
to recognize loss.

Other tax effects
Parent inherits subsidiary’s AB in assets:
IRC 334(b)(1)
 Parent inherits tax attributes: IRC 381

–
–
–
–

EP: IRC 381(c)(2)
capital loss carryovers:
NOL carryover:
Potential depreciation recapture: 1245(b)(3)
Parent’s AB on subsidiary’s stock
disappears.