Liquidations & Reorganizations, p. 12
ACC570 - Chapter 20
LIQUIDATING DISTRIBUTIONS (& REORGANIZATIONS OVERVIEW )
I. Tax Consequences of Corporate Liquidations. - General rule is to treat the distribution as a sale/exchange. A corporation may liquidate without surrendering its charter to the state and undergoing dissolution. Dissolution may never occur if the charter is retained to protect the corporate name.
A. Shareholder recognizes gain or loss is extent that money and the FMV of property received exceeds the adjusted basis of the stock.
B. Corporation recognizes gain or loss as if the property were sold to the distributee.
II. Effects of Liquidating on the Shareholders.
A. Amount of Recognized Gain or Loss.
Ø G(L) = amount realized - basis of stock.
Ø Amount realized = FMV property received - liabilities assumed.
B. When Was Stock Acquired? A shareholder must compute gain or loss separately for each share or block of stock owned.
C. Partially Liquidating Distributions. The shareholder's basis is first recovered and then gain is recognized once the basis of a particular share or block of stock has been fully recovered.
D. Basis of Property Received in the Liquidation.
Ø FMV on the date of distribution.
Ø holding period starts on the day after the distribution.
E. Installment Obligations Received by a Shareholder. (Exception to the normal rule of valuing assets at FMV) If an installment note was acquired by the corporation within 12 months after adoption of the liquidation plan, installment method of recognition is allowed for the shareholder. Shareholder allocates stock basis to all assets distributed. Gain is deferred on the installment note; gain is recognized on all other assets.
III. Effect on the Liquidating Corporation.
A. Recognizes Gain or Loss When Property is Distributed in Redemption of Stock.
1. Liabilities Assumed by the Shareholder. Use the same rule as in dividend distributions, i.e., gain measured by greater of (FMV or debt) less basis.
2. Exceptions to the General Rule on Loss Recognition.
a. No loss on distributions of property to a related person (Sec. 267 rules - >50% owner) if the distribution is:
(1) NOT pro rata, or
(2) the property being distributed is disqualified property (defined as property acquired by corporation within last five years under a Sec. 351 transaction).
b. Built-in losses property distributions
(1) Applies to property contributed to corporation within 2 years of liquidation adoption that had a built-in loss (presumption rule).
(2) The effect of this limit is to deny any built-in loss at the acquisition date. Only post-acquisition losses may be recognized.
c. Examples. A and B own C Corp. (60% & 40%). C has two assets to distribute in liquidation: #1 has FMV of $60 and basis of $80; #2 has FMV of $40 and basis of $30.
* Distributes #1 to A and #2 to B:
* Distributes #1 and #2 to A and B as joint owners (60/40).
* Joint distribution again, except that asset #1 was contributed in a Sec. 351 transaction within last 5 years.
* Joint distribution again, except that asset #1 was contributed within 2 years, where basis was $80 and FMV was $65.
IV. Liquidation of a Controlled Subsidiary Corporation. (§332)
A. General Rules.
1. No gain or loss is recognized by either party when a controlled subsidiary corporation is liquidated into its parent corporation. Treatment is mandatory.
a. Minority interest shareholders use the general rule, i.e., taxable liquidation. However, the subsidiary corporation cannot recognize loss on distribution to minority shareholders.
2. Basis of property received is its basis in the hands of the subsidiary. Property received by minority shareholders has a basis equal to its FMV because gain or loss is recognized.
B. Requirements
1. Stock Ownership. The parent corporation must own 80% of all classes of stock (other than certain nonvoting preferred issues) from the date on which the plan of liquidation is adopted until receipt of the property of the subsidiary. The Sec. 318 attribution rules do not apply.
2. Timing of Distributions. The subsidiary corporation must distribute all properties within one tax year, over 4 years if a formal plan is adopted.
3. Subsidiary must be Solvent.
C. § 338 Election.
1. General Treatment
a. Deemed Sale. Subsidiary corporation is treated as having sold all of its assets at their FMV in a single transaction at the close of the acquisition date. Gain recognized.
b. Basis of the Assets. Stepped-up (down) to the amount paid by the acquiring corporation for the target corporation stock. This is called the adjusted grossed-up basis, because the new basis must reflect the % owned by parent.
c. Allocation of Basis to Individual Assets. The adjusted grossed-up basis is allocated among four classes of assets using the residual method. Any amount not allocated to tangible or intangible assets of the target corporation is allocated to goodwill and going concern value.
2. Requirements
a. Acquiring corporation must purchase 80% or more of the target corporation's voting stock and total value of all classes of stock (except nonvoting preferred) during a 12-month period beginning on the day the first purchase is made.
b. Sec. 338 election must be made not later than 8 ½ months after the month in which the acquisition date occurs.
V. REORGANIZATIONS
A. General Rules.
1. Tax-free exchange
2. Shareholders
a. No gain or loss recognized when they exchanges stock and securities for that in the new corporation.
b. Basis in new stock & securities is a carryover basis.
c. If boot is received (i.e., property other than stock or securities), gain is recognized to the extent of boot received (gain would increase basis).
3. Corporations
a. No gain or loss recognized by any of the corporations involved.
b. Basis of property transfers from one corporation to the other.
B. Types of Reorganizations follow….
Liquidations & Reorganizations, p. 12
TAX-FREE CORPORATE REORGANIZATIONS SUMMARY
Type / Description / Property Acquired / Consideration that can be used / What happens to Target (B) Corporation? / Advantages / DisadvantagesA / Merger or consolidation / All assets & liabilities of B Corp. / Stock, securities, & other property of A Corp. / B Corp. is liquidated as part of the merger / Doesn’t have to be voting stock / All of B Corp’s liabilities are assumed by A Corp.; State merger laws
B / Stock-for-stock exchange / At least 80% of voting and nonvoting stock of B Corp. / Voting stock of A Corp. / Remains in existence as a subsidiary of A Corp. / Procedures are easier; stock can be acquired directly from shareholders / Only voting stock of A Corp. can be used.
C / Assets-for-stock exchange / “Substantially all” of the assets of B Corp. (and some or all of its liabilities) / Stock, securities, & other property of A Corp, provided 80% of the assets are acquired for voting stock / Normally liquidated / Very similar to, but less complex than, a Type A reorg.;
Cash can be used, as long as < 20% of total / B Corp. must distribute the stock, securities, and other property to its shareholders
D / Divisive – (spin-off, split-off, or split-up) / Part or all of Parent corp’s assets (maybe liabilities) are transferred to a controlled subsidiary / Stock, securities, & other property of Subsidiary corp. / Stock & securities of the Subsidiary corp must be distributed. Parent may be liquidated or stay in existence / Permits corporate division without tax consequences
E / Recapitalization / A change to the capital structure of a single corporation occurs / Bonds for stock, stock for stock, bonds for bonds. / Corporation remains in existence / Allows for a major change in makeup of stockholders’ equity
F / Change in identity, form, or place or organization / Single corp. assets or stock are transferred to a new corporation / Stock, securities, & other property of the new corporation / Old corporation is liquidated. / New corporation is treated as same as the Old corporation; all tax attributes of OldCo transfer
G / Court-approved bankruptcy reorganization / Part or all of the assets (maybe some liabilities) of B Corp. are transferred to another corporation / Stock, securities, & other property of A Corp. / B Corp. may be liquidated or remain in existence / Creditors can exchange notes for stock tax-free; don’t have to follow state merger laws.
Liquidations & Reorganizations, p. 12
TYPE A REORGANIZATION
STATUTORY MERGER
A shareholders
own
B shareholders
own
Transaction
B shareholders
Result
A shareholders
own
B shareholders own
TYPE A REORGANIZATION
CONSOLIDATION
A shareholders
own
B shareholders
own
Transaction
A shareholders B shareholders
Result
A shareholders
own
B shareholders own
TYPE B REORGANIZATION
A shareholders B shareholders
own own
Transaction
B shareholders
Result
A shareholders
own
B shareholders own
TYPE C REORGANIZATION
A shareholders B shareholders
own own
Transaction
B shareholders
Result
A shareholders
own
B shareholders own
TYPE D REORGANIZATION
SPIN-OFF
P shareholders
own
Transaction
P shareholders
Result
P shareholders
own
ownTYPE D REORGANIZATION
SPLIT-OFF
P shareholders
own
Transaction
Some
P shareholders
Result
Former
P shareholders P shareholders
own own
TYPE D REORGANIZATION
SPLIT-UP
P shareholders
own
Transaction
P shareholders
P shareholders
Result
Former Former
P shareholders P shareholders
own own