The regulations under Section 332 suggest that a liquidation has occurred 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.
If a corporation was not in existence throughout an annual accounting period (either calendar year or fiscal year), the corporation not only is required submit the deregistration documents at the Secretary of State's company registration office, but also is required file a final tax return for that fractional part of a year during which it was in existence.
The Taxation of Liquidations
Generally, for U.S. Federal income tax purposes, property exchanges are taxable events. In a section 331 liquidation, the amounts received by a shareholder in complete liquidation of a corporation are generally treated as full payment in exchange for the liquidating corporation’s stock. The shareholder will compare the value of the assets received in the liquidation to their stock basis in order to compute gain or loss.
Unless a nonrecognition provision of Section 332 of the Code applies. Under Section 332, which provides that no gain or loss is recognized by a corporate shareholder on the receipt of property distributed by its 80%- owned corporate subsidiary in complete liquidation.
Similarly, the liquidating corporation recognizes no gain or loss on its distribution to the 80% corporate shareholder of any property in a complete liquidation to which Section 332 applies.
Example, P owns all of the stock of S and has a basis of $100 in its S stock. If P receives property worth $125 in a taxable liquidating distribution from S, P will have gain of $25.
If S is liquidated in a transaction that qualifies under Section 332, P will have no gain in the transaction and it will take a carryover basis in the S assets it received.
The Nontaxable Corporate Liquidation
The Regulations promulgated thereunder Section 332, the liquidation of a corporate subsidiary into its parent must include the following essential components to qualify as a liquidation:
(1) There must be the adoption of a plan of liquidation (the “Adoption of Plan Requirement”);
(2) The corporate subsidiary must be solvent with respect to its common stock (the “Solvency Requirement”);
(3) The parent corporation must own at least 80% of the corporate subsidiary’s stock within the meaning of Section 1504(a)(2) at the time the plan of liquidation is adopted and at all times thereafter until the liquidation is effective (the “80% Ownership Requirement”);
(4) There must be a complete cancellation or redemption of all of the corporate subsidiary’s stock pursuant to the plan of liquidation (the “Elimination of Subsidiary Stock Requirement”);
(5) The property distributions must be completed within the taxable year or in the case of a series of distributions, within three years from the close of the taxable year during which the first distribution is made (the “Timing Requirement”); and
(6) There cannot be a reincorporation of the liquidated subsidiary’s assets pursuant to the same plan or arrangement (the “Liquidation-Reincorporation Limitation”).
Deemed Liquidations
Under Regs. §§ 301.7701-2 and 301.7701-3 the conversion of corporation to a limited liability company (“LLC”) can cause a liquidation for U.S. Federal income tax purposes.
Under Reg. §301.7701-3(g)(1)(ii) if an eligible entity classified as a corporation validly elects to be classified as a partnership, the corporation is treated as distributing all of its assets and liabilities to its shareholders in liquidation of the corporation, and immediately thereafter, the shareholders are treated as transferring all of the distributed assets and liabilities to a newly formed partnership.
Because of the tax fiction, the liquidation is merely a “deemed liquidation” for U.S. federal income tax purposes.
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