chapter c6

Prentice Hall's Federal Taxation 2016: Corporations, 29e (Pope)Chapter C6: Corporate Liquidating Distributions

LO1: Overview of Corporate Liquidations

1) Liquidation and dissolution have the same legal meaning.Answer: FALSEPage Ref.: C:6-4Objective: 1

2) In a complete liquidation of a corporation, which of the following is false?A) All stock of the liquidating corporation is canceled or redeemed.B) The corporation ceases to be a going concern.C) The corporation divests itself of substantially all its properties.D) The liquidation of a corporation means it has undergone dissolution.Answer: DPage Ref.: C:6-3 and C:6-4Objective: 1

3) When a corporation liquidates, it performs three activities. What is the general order of these activities in a plan of liquidation?A) pay debts, distribute property to shareholders, and wind up its affairsB) wind up its affairs, distribute property to shareholders, pay debtsC) pay debts, wind up its affairs, and distribute property to shareholdersD) wind up its affairs, pay debts, and distribute property to shareholdersAnswer: DPage Ref.: C:6-4Objective: 1

4) Moya Corporation adopted a plan of liquidation last year. All but a nominal amount of Moya's assets are distributed to its shareholders within the year. Which of the following statements is not true?A) The liquidation of Moya Corporation means the corporation has undergone dissolution.B) Moya Corporation retains its state charter.C) Moya Corporation's existence is preserved.D) Moya Corporation has been liquidated for tax purposes.Answer: APage Ref.: C:6-4Objective: 1

5) Are liquidation and dissolution the same? Explain your answer.Answer: Liquidation status continues from the time the plan of liquidation has been formally or informally adopted until the corporation ceases to be a going concern or until it has divested itself of all its property. Dissolution is a legal term that implies that the corporation has surrendered the charter it originally received from the state. A corporation generally may complete its liquidation prior to undergoing dissolution. Dissolution may never occur if the corporation retains its charter to protect its corporate name from being acquired by another party.Page Ref.: C:6-3 and C:6-4Objective: 1

6) Bluebird Corporation owns and operates busses and has decided to liquidate its operations. Victor, who owns 80% of the company's stock, will receive all of the busses, repair parts inventory, and all tools and equipment. He plans to start a bus company in another town. Penny, who owns 20% of the stock, wants nothing to do with the new bus business and will receive a cash distribution. Bluebird will incur about $20,000 of expenses

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in connection with the liquidation. What tax issues should Victor, Penny, and Bluebird consider with respect to the liquidation?Answer: Penny and Victor should consider the following tax issues:

• What gains or losses does Bluebird recognize on the two distributions?• Does Bluebird have to file a corporate tax return for the portion of the final tax year that it is in existence? If so, what income and expenses are included in the return?• Can Bluebird deduct the liquidation expenses on its final tax return?• What are the amounts and characters of the gain or loss that Penny and Victor recognize upon surrendering their Bluebird stock?• What basis does Victor take for the noncash assets that he receives?• What happens to Bluebird's tax attributes?

Bluebird Corporation will need to recognize any gain realized on the distribution of the Bluebird busses, support vehicles, repair parts inventory, tools, and equipment. Bluebird recognizes no loss on the disposition of these items because they are distributed to a related party (Victor owns 80% of Bluebird). Penny recognizes no gain on the distribution because she receives only cash. Victor and Penny will need to determine their realized and recognized gains on the liquidation. Bluebird Corporation can deduct the liquidation expenses in its final tax return. Any NOLs incurred in the final year can be carried back to the two preceding tax years. A substantial cost may be incurred in liquidating the corporation. Perhaps Victor should consider buying Penny's stock and keep operating Bluebird Corporation in the new city. This way the liquidation tax (e.g., on corporate and shareholder-level gains) will be avoided.Page Ref.: C:6-2 through C:6-9, C:6-16, C:6-17Objective: 1

LO2: General Liquidation Rules

1) In a complete liquidation, a liability assumed by a shareholder reduces the shareholder's amount realized.Answer: TRUEPage Ref.: C:6-5Objective: 2

2) In general, a noncorporate shareholder that receives a distribution in complete liquidation of the liquidating corporation recognizes his or her entire realized gain as a capital gain.Answer: TRUEPage Ref.: C:6-6Objective: 2

3) The adjusted basis of property received in a complete liquidation is its fair market value on the distribution date.Answer: TRUEPage Ref.: C:6-6Objective: 2

4) Generally, a corporation recognizes a gain, but not a loss, on a liquidating distribution.Answer: FALSEPage Ref.: C:6-6Objective: 2

5) Section 336 prevents recognition of a loss when making a pro rata distribution of property to a related person.Answer: FALSEPage Ref.: C:6-8


Objective: 2

6) Identify which of the following statements is false.A) The tax attributes of the liquidating corporation carry over to the shareholders when the liquidation is conducted under the general liquidation rules.B) Baker Corporation was formed in a Sec. 351 exchange three years ago by Emil, Fred, and George who own equal stock interests. The corporation can be liquidated tax-free under the special liquidation rules of Secs. 332 and 337.C) The terms "liquidation" and "dissolution" are synonymous.D) All of the above are false.Answer: DPage Ref.: C:6-3 through C:6-10Objective: 2

7) Liquidation rules generally are applied the same to the following organizations except forA) subsidiary corporations (80% controlled).B) C corporations.C) S corporations.D) subsidiary corporations (less than 80% controlled).Answer: APage Ref.: C:6-5Objective: 2

8) Riverwalk Corporation is liquidated, with Juan receiving $5,000 in money and other property having a $6,000 FMV. Juan's basis in his Riverwalk stock is $8,000. Upon liquidation, Juan must recognize a gain ofA) 0.B) $2,000.C) $3,000.D) $11,000.Answer: CPage Ref.: C:6-5; Example C:6-3Objective: 2


9) Riverwalk Corporation is liquidated, with Juan receiving $5,000 in money, other property having a $6,000 FMV, and a $1,000 mortgage on the property. Juan's basis in his River walk stock is $8,000. Upon liquidation, Juan must recognize a gain ofA) 0.B) $2,000.C) $3,000.D) $11,000.Answer: BPage Ref.: C:6-5; Example C:6-4Objective: 2

10) Texas Corporation is undergoing a complete liquidation and distributes land to Robert, one of its shareholders, in exchange for all of Robert's stock. The land has a basis of $300,000 and an FMV of $400,000 on Texas Corporation's books and is subject to a $325,000 liability. Robert assumes the liability on the property. Robert's basis in his Texas Corporation stock is $100,000. What is the amount of gain or loss recognized by Robert on the distribution?A) $175,000 gainB) $25,000 gainC) $25,000 lossD) No gain or loss is recognized.Answer: CExplanation: FMV of property $ 400,000Minus: liability assumed ( 325,000)Amount realized $ 75,000Minus: basis of stock ( 100,000)Loss recognized ($ 25,000)

Page Ref.: C:6-5Objective: 2

11) Robot Corporation is liquidated, with Marty receiving property having an adjusted basis of $60,000 and an FMV of $90,000. The property is subject to a $80,000 mortgage, which Marty assumes. Marty's basis in the Robot stock surrendered is $50,000. Marty must recognizeA) a $40,000 loss.B) no gain or loss.C) a $60,000 gain.D) none of the aboveAnswer: AExplanation: FMV of property $ 90,000Minus: liability assumed ( 80,000)Amount realized $ 10,000Minus: basis of stock ( 50,000)Loss recognized ($ 40,000)


12) Identify which of the following statements is true.A) The method of accounting used by shareholders involved in a complete liquidation is relevant when determining the year in which the shareholder's gain or loss should be reported.B) An accrual method of accounting taxpayer recognizes his/her realized gain on a


corporate liquidation when there has been actual or constructive receipt of the liquidating distribution(s).C) If a shareholder assumes or acquires liabilities of the liquidating corporation, the amount of these liabilities does not reduce the amount realized by the shareholder.D) All of the above are false.Answer: APage Ref.: C:6-6Objective: 2

13) Property received in a corporate liquidation by a noncorporate shareholder hasA) a basis equal to its basis on the liquidating corporation's books increased by any gain recognized by the shareholder upon receipt of the property. Its holding period includes the holding period of the shareholder's stock.B) a basis equal to its basis on the liquidating corporation's books increased by any gain recognized by the shareholder upon receipt of the property. Its holding period commences on the day after the distribution date.C) a basis equal to its FMV reduced by any liabilities assumed by the shareholder. Its holding period commences on the day after the distribution date.D) a basis equal to its FMV. Its holding period commences on the day after the distribution date.Answer: DPage Ref.: C:6-6Objective: 2

14) Identify which of the following statements is true.A) In general, a noncorporate shareholder that receives a distribution in complete liquidation of the liquidating corporation recognizes his or her entire realized gain as a capital gain.B) The basis for nonmoney property received by a noncorporate shareholder as part of a liquidating distribution is the same as its basis on the books of the liquidating corporation.C) The liquidating corporation does not recognize gains and losses when making a distribution of nonmoney property.D) All of the above are false.Answer: APage Ref.: C:6-6Objective: 2

15) Identify which of the following statements is true.A) A loss recognized by a shareholder upon complete liquidation of a corporation may not qualify for ordinary loss treatment if the stock is Sec. 1244 stock.B) The loss that is recognized by an individual shareholder on the liquidation of a corporation is a capital loss, up to certain limits, if the stock is Sec. 1244 stock.C) The loss recognized by a corporate shareholder on the worthlessness of the controlled subsidiary's stock is an ordinary loss.D) All of the above are false.Answer: CPage Ref.: C:6-6Objective: 2

16) Under a plan of complete liquidation, Coast Corporation distributes land with a $300,000 adjusted basis and a $400,000 FMV to William, a 25% shareholder. William has a $200,000 basis in his Coast stock. The land is inventory in the hands of Coast Corporation. Coast Corporation must recognizeA) no gain.B) $100,000 of ordinary income.C) $100,000 of long-term capital gain.D) $200,000 of ordinary income.


Answer: BPage Ref.: C:6-6Objective: 2

17) Identify which of the following statements is true.A) With limited exceptions, a loss can be recognized by a liquidating corporation when it makes a liquidating distribution of property that has declined in value.B) When computing the corporate-level gain on a liquidating distribution, the FMV of the property cannot exceed the liability assumed or acquired by the shareholder.C) The FMV of property distributed by a liquidating corporation can be less than the amount of the liability assumed or acquired by the shareholder.D) All of the above are false.Answer: APage Ref.: C:6-6Objective: 2

18) Under a plan of complete liquidation, Key Corporation distributes land (not a disqualified property) with an adjusted basis of $410,000 and an FMV of $300,000 for all Sharon's stock. Sharon's basis in her 5% interest in the Key stock is $250,000. Find Sharon's basis in the land and Key Corporation's recognized gain or loss.

A) Basis Recognized Gain/Loss$300,000 $110,000 loss

B) Basis Recognized Gain/Loss$250,000 $110,000 loss

C) Basis Recognized Gain/Loss$300,000 $0

D) Basis Recognized Gain/Loss$250,000 $0

Answer: APage Ref.: C:6-5 through C:6-7Objective: 2

19) Barnett Corporation owns an office building that cost $900,000. Barnett has taken $600,000 of depreciation on the building. The property is subject to a $600,000 mortgage. The office building has a current FMV of $400,000. Barnett Corporation is liquidated and the office building is distributed to a single individual shareholder who assumes the mortgage. Barnett Corporation must recognizeA) no gain or loss.B) a $100,000 gain.C) a $300,000 gain.D) none of the aboveAnswer: CExplanation: The building is deemed to be worth at least the amount of the liability that is assumed. The corporation's basis in the building is $300,000 (cost less depreciation) and the liability assumed is $600,000; therefore, Barnett's gain is $300,000.

Deemed FMV $600,000 *Acquisition cost $900,0006

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Minus: adjusted basis (300,000) Minus: depreciation ( 600,000)Recognized gain $300,000 Adjusted basis $300,000


20) Identify which of the following statements is true.A) A liquidating distribution of property other than a disqualified property that is made ratably to all shareholders (based on their stockholdings) will permit the recognition of loss on the portion of the distribution that is made to a related person.B) A subsidiary corporation can recognize losses on distributions to either the parent corporation or minority shareholders in a Sec. 332 liquidation.C) Section 336 prevents recognition of a loss when making a pro rata distribution of property to a related person.D) All of the above are false.Answer: APage Ref.: C:6-8Objective: 2

21) Identify which of the following statements is true.A) The loss realized on the sale of a property is disallowed when such property was received by a corporation as a contribution of capital in a transaction having as its principal purpose the recognition of loss pursuant to the corporation's subsequent liquidation later in the same taxable year.B) Losses claimed in a tax return filed before the adoption of the plan of liquidation are not restricted by Sec. 336(d)(2).C) Properties acquired by a liquidating corporation as a capital contribution occurring within three years of the adoption of a plan of liquidation are generally presumed to have a tax avoidance motive.D) All of the above are false.Answer: APage Ref.: C:6-8Objective: 2


22) The stock of Cooper Corporation is 70% owned by Carole and 30% owned by Carole's brother, Chris. During 2013, Chris transferred property (basis of $100,000 and FMV of $120,000) as a contribution to the capital of Cooper. During February 2014, Cooper adopted a plan of liquidation and subsequently made a pro rata distribution of the property back to Carole and Chris. At the time of the liquidation, the property had an FMV of $80,000. What amount of loss can be recognized by Cooper on the distribution of property?A) $0B) $6,000C) $12,000D) $20,000Answer: AExplanation: No loss can be recognized because Carole and Chris (brother and sister) each constructively own 100% of the corporation and the property was acquired in a carryover-basis transaction within the five-year period preceding the liquidating distribution.Page Ref.: C:6-8Objective: 2

23) Last year, Toby made a capital contribution of a pretzel maker having a $2,000 adjusted basis and a $200 FMV to Keke Corporation in exchange for additional stock. This year, Keke Corporation adopted a plan of liquidation. Prior to the adoption of the liquidation plan, Keke had not used the pretzel maker in connection with the conduct of its trade or business. Which of the following statements is true?A) Keke Corporation may recognize a loss of $1,800.B) Keke Corporation may recognize a loss of $200.C) Keke Corporation's basis for determining the loss will be $2,000.D) Keke Corporation's basis for determining the loss will be $200.Answer: DPage Ref.: C:6-9; Example C:6-11Objective: 2

24) Toby made a capital contribution of a pretzel maker having a $2,000 adjusted basis and a $200 FMV to Keke Corporation in exchange for additional stock last year. Later that same year, Keke sold the pretzel maker for $300. This year, Keke adopted a plan of liquidation. Previously, Keke had never used the pretzel maker in connection with the conduct of its trade or business. The sale was reported on Keke's current tax return. What reporting option does Keke Corporation not have because of its plan of liquidation?A) File an amended tax return for the tax year in which the tax loss was originally claimed.B) Recapture the loss on the tax return for the year the plan for liquidation was adopted.C) Recognize a gain of $100 for the current year.D) none of the aboveAnswer: CPage Ref.: C:6-9; Example C:6-11Objective: 2


25) Dexer Corporation is owned 70% by Amy and 30% by Brad. Dexer Corporation owns Eagle Corporation stock with a $50,000 adjusted basis and a $30,000 FMV. The stock is not disqualified property. As part of a complete liquidation, the Eagle Corporation stock is distributed to Amy. Amy's basis in her Dexer stock is $40,000. Dexer Corporation will recognizeA) no loss.B) a $10,000 loss.C) a $20,000 loss.D) none of the aboveAnswer: APage Ref.: C:6-10Objective: 2

26) Lake Corporation distributes a building used in its business to Sandy in exchange for all of her Lake stock. Sandy's basis in her stock is $30,000 and the property she receives has a $90,000 FMV. As part of the distribution, Sandy assumes a liability associated with the property of $65,000. The property's basis prior to the liquidating distribution was $25,000. What are the tax consequences of the distribution to Sandy? To Lake Corporation?Answer: Sandy will recognize a $5,000 capital loss on the distribution [($90,000 - $65,000) - $30,000]. The basis of the building to Sandy will be $90,000. The holding period for the building begins on the day after the distribution. The $90,000 FMV of the assets is reduced by the $65,000 liability assumed in determining the amount of the distribution to Sandy. Lake Corporation will recognize a $65,000 [($25,000 net FMV of assets + $65,000 release from liabilities) - $25,000 adjusted basis] Sec. 1231 gain on the distribution. Some of the gain may be ordinary income under Sec. 291 (see Chapter C3).Page Ref.: C:6-5Objective: 2

27) Under the general liquidation rules, Kansas Corporation is liquidated, with Sam Topeka receiving $20,000 in cash plus other property having a $24,000 FMV. Sam Topeka's basis in his Kansas stock is $32,000. What is Sam Topeka's amount realized and gain recognized on the liquidation?Answer: Sam Topeka's amount realized is $44,000 ($24,000 + $20,000). His recognized gain on the liquidation is $12,000 ($44,000 - $32,000).Page Ref.: C:6-5; Example C:6-3Objective: 2

28) Under the general liquidation rules, Missouri Corporation is liquidated, with Jefferson receiving $5,000 in cash plus other property having a $6,000 FMV and assuming a $2,000 mortgage on the property. Jefferson's basis in his Missouri stock is $8,000. What is Jefferson's amount realized and gain or loss recognized on the liquidation?Answer: Jefferson's amount realized is $9,000 ($5,000 + $6,000 - $2,000). His recognized gain on the liquidation is $1,000 ($9,000 - $8,000).Page Ref.: C:6-5; Example C:6-4Objective: 2


29) Albert receives a liquidating distribution from Glidden Corporation as part of a complete redemption of its stock. Albert receives cash of $5,000 and other property with an adjusted basis of $6,000 and an FMV of $10,000. Albert's basis in the Glidden stock surrendered is $8,000. How much gain does he recognize?Answer: Cash $ 5,000Plus: FMV of other property received 10,000Amount realized $15,000Minus: basis of stock ( 8,000)Recognized gain $ 7,000Page Ref.: C:6-5Objective: 2

30) Mary receives a liquidating distribution from Snell Corporation as part of a redemption of all of its stock. Mary's basis in the Snell stock is $10,000. In exchange for her stock, Mary receives property with an $8,000 basis and a $15,000 FMV that is subject to a $3,000 mortgage. Mary also receives cash of $5,000. What is Mary's recognized gain?Answer: FMV of property received $15,000Plus: cash 5,000Minus: mortgage assumed ( 3,000)Amount realized $17,000Minus: basis of stock (10,000)Recognized gain $ 7,000Page Ref.: C:6-5; Example C:6-4Objective: 2

31) John and June, husband and wife, have owned Ruby Corporation for a number of years. Their basis in the Ruby stock, which they own jointly, is $200,000. The Ruby stock is Sec. 1244 stock. Ruby Corporation liquidates, and John and June receive the following from the corporation: accounts receivable, $30,000 FMV; a car, $21,000 FMV; office furniture, $11,000 FMV; and $25,000 in cash. What is the amount and character of their gain or loss?Answer: $30,000 + $21,000 + $11,000 + $25,000 = $87,000 total distribution; $87,000 - $200,000 = ($113,000) recognized loss; $100,000 ordinary loss under Sec. 1244 and $13,000 long-term capital loss. The Sec. 1244 loss ceiling is $100,000 for a married couple filing a joint return, thereby causing the remaining $13,000 to be a long-term capital loss.Page Ref.: C:6-5 and C:6-6Objective: 2


32) Charlene and Dennis each own 50% of Brewster Corporation and have owned it for five years. The adjusted bases of their Brewster stock are $80,000 and $40,000 respectively. Brewster Corporation liquidates and distributes $60,000 to Charlene in exchange for her stock. It distributes a parcel of land with a $140,000 FMV which is subject to a $90,000 mortgage to Dennis in exchange for his stock. Dennis assumes the mortgage and also receives $10,000 in cash.a) What is the character and amount of each shareholder's gain or loss?b) What is each shareholder's basis in the property received in the liquidation?Answer: a) Charlene: $60,000 - $80,000 = $20,000 long-term capital loss.

Dennis: [($140,000 - $90,000) + $10,000] - $40,000 = $20,000 long-term capital gain. Here, the liability reduces the amount realized.b) Charlene, $60,000 cash; Dennis, $140,000 basis for land and $10,000 cash.Page Ref.: C:6-5 and C:6-6Objective: 2

33) Jack Corporation is owned 75% by Sherri and 25% by Mark. Sherri and Mark have $125,000 and $50,000 bases in their stock, respectively. Jack Corporation adopts a plan of liquidation on March 1. On April 12, Sherri receives the following property as a liquidating distribution: cash of $30,000; land, $125,000 FMV; and 150 shares of Green Corporation stock, $30,000 FMV. The land is subject to a $20,000 mortgage. On the same date, Mark receives $10,000 FMV of Green stock (50 shares) and cash of $45,000 as a liquidating distribution. The land has a basis of $50,000 and the stock has a basis of $70,000 in Jack Corporation's hands. Both are capital assets to Jack Corporation and have been held for a number of years.a) What is the amount and character of Jack Corporation's recognized gain or loss on the liquidating distributions?b) What are the amounts and characters of Sherri and Mark's recognized gains or losses?c) What are the bases of the land and stock to Sherri and Mark?Answer: a) Land: ($105,000 net FMV + $20,000 liabilities) - $50,000 = $75,000 long-term capital gain.stock: $40,000 - $70,000 = $30,000 realized long-term capital loss. Jack recognizes the entire loss because the stock is not disqualified property and is distributed in the same proportion (25% for Mark and 75% for Sherri) as Mark and Sherri's stockholdings.b) Sherri: ($30,000 + $125,000 + $30,000 - $15,000 liabilities) - $125,000 = $45,000 capital gain.Mark: ($10,000 + $45,000) - $50,000 = $5,000 capital gain.c) Sherri: land, $125,000; stock, $30,000. Mark: stock, $10,000.Page Ref.: C:6-5 through C:6-9Objective: 2

34) How is the gain/loss calculated if a shareholder has acquired stock at different times and at varying prices?Answer: A shareholder who has purchased blocks of stock at different times and prices must calculate the gain or loss on each block separately. It is possible to have both gains and losses existing in the same liquidating distribution and for the gains and losses to have different characters.Page Ref.: C:6-6Objective: 2


35) Specialty Corporation distributes land to one of its shareholders, Sam, as part of a plan of liquidation. The land, which was used in Specialty's business, has an adjusted basis of $50,000 and an FMV of $130,000 on the date of distribution. Sam's basis in Specialty Corporation stock is $100,000. What is the amount and character of the gain/loss recognized by Specialty Corporation? What is the amount and character of the gain/loss recognized by Sam?Answer: Specialty recognizes an $80,000 ($130,000 - $50,000) Sec. 1231 gain. Sam recognizes a $30,000 ($130,000 - $100,000) capital gain. Page Ref.: C:6-6; Example C:6-5Objective: 2

36) What event determines when a cash or accrual method of accounting taxpayer reports a liquidating distribution?Answer: A shareholder who uses the accrual method of accounting reports the gain or loss using accrual concepts (i.e., the gain or loss is recognized when all the events have occurred that fix the amount of the liquidating distribution and when the shareholders are entitled to receive the distribution upon surrender of their shares). A shareholder who uses the cash method of accounting reports the gain when he or she has actual or constructive receipt of the liquidating distribution.Page Ref.: C:6-6Objective: 2

37) Under Illinois Corporation's plan of liquidation, the corporation distributes land to one of its shareholders, Springer. The land, which is used in Illinois trade or business, has a $20,000 adjusted basis and a $60,000 FMV on the distribution date. What are the tax consequences of this distribution to Illinois and Springer?Answer: Illinois Corporation recognizes a $40,000 ($60,000 - $20,000) Sec. 1231 gain when it makes the liquidating distribution. Springer recognizes a capital gain to the extent that the land's FMV exceeds his basis in the Illinois stock. Springer's basis for the land is its $60,000 FMV.Page Ref.: C:6-6; Example C:6-5Objective: 2


38) Explain the difference in tax treatment between a partial liquidation and a complete liquidation.Answer: A complete liquidation is defined by Reg. Sec. 1.3322(c) as one or a series of distributions made by a liquidating corporation that completely cancels or redeems all of its stock in accordance with a plan of liquidation. A partial liquidation is defined by Sec. 302(e) as a distribution that (1) is not essentially equivalent to a dividend (when determined at the corporate level rather than at the shareholder level), and (2) is pursuant to a plan of liquidation and occurs within the tax year in which the plan is adopted or within the succeeding tax year. Generally, a partial liquidation involves the corporation either ceasing to conduct a trade or business (while still continuing to conduct a second trade or business) or contracting its business activities. In either case, the corporation remains in existence after the partially liquidating distribution.

A complete liquidation is taxed under Code Secs. 331 and 336. A partial liquidation is taxed under Code Secs. 302(b) and 311. The complete liquidation is taxed to the extent the shareholder recognizes a gain or loss, which is computed by comparing the FMV of the property received to the adjusted basis of the stock redeemed. When the shareholder receives a series of liquidating distributions, the distribution is taxed once the FMV of the property received exceeds the adjusted basis of the stock held. All basis is recovered first before the shareholder recognizes any gain. A partial liquidation results in exchange treatment for a noncorporate shareholder under Sec. 302(b)(4). A corporate shareholder is eligible for exchange treatment only if the distribution qualifies as an exchange under the stock redemption rules of Secs. 302(b)(1)-(b)(3). The shareholder recognizes a loss only when he or she receives the final liquidating distribution.Page Ref.: C:6-3 through C:6-9Objective: 2

39) Under what circumstances does a liquidating corporation not recognize a gain or loss when making a distribution?Answer: A liquidating corporation does not recognize gain or loss under four circumstances. These are:1) Liquidation of a subsidiary corporation — The liquidating corporation recognizes no gain or loss on liquidating distributions made to a parent corporation that owns at least 80% of the subsidiary's stock.2) Distributions to minority shareholders — The liquidating corporation recognizes gain but not loss on liquidating distributions made to minority shareholders when the Sec. 332 nonrecognition rules apply to the parent corporation.3) Distributions to related persons — Loss recognition is disallowed when the liquidating corporation makes a distribution to a related person, as defined in Sec. 267(b), if (1) the distribution is not pro rata or (2) the property distributed is disqualified property. Disqualified property is property acquired by the corporation in a Sec. 351 tax-free formation or as a capital contribution during the five-year period ending on the distribution date or property having an adjusted basis that carries over from a disqualified property.4) Sales having a tax-avoidance purpose — Loss recognition is restricted where property is transferred to the corporation in a Sec. 351 transaction or capital contribution after a date two years before the date that the corporation adopts a plan of complete liquidation. Tax avoidance is inferred in these situations unless the corporation uses the property in its trade or business.

A less-often encountered situation involves distributions or sales of a subsidiary corporation's stock. A corporation can elect under Sec. 336(e) to treat the sale, exchange, or distribution of a subsidiary's stock as a disposition of all the subsidiary's assets, resulting in no gain or loss being recognized on the sale, exchange, or distribution of the stock.Page Ref.: C:6-6 through C:6-9 and C:6-12 and C:6-13Objective: 2


40) Chip and Dale are each 50% owners of Tree Corporation, a holding company. They have each held their stock since the company was formed five years ago. Tree's money is invested almost entirely in stocks, bonds, rental real estate, and land. All of the stocks are traded on the New York Stock Exchange except for 1,000 shares of Conifer Corporation stock. Conifer is privately held by 50 individuals. Last year, Conifer reported about $2 million in net income. During a meeting with Chip and Dale, you discover that they plan to liquidate Tree Corporation as soon as possible to avoid the personal holding company tax. What tax issues should Chip and Dale consider with respect to this liquidation?Answer: Chip and Dale should consider the following tax issues:

• Can the personal holding company tax be avoided by changing the investment/operating decisions of Tree Corporation?• What gain or loss does Tree Corporation recognize if a liquidation occurs?• What gains or losses do Chip and Dale recognize if Tree Corporation is liquidated?• Is it possible for the open transaction doctrine to apply to the liquidation of Tree Corporation due to an inability to value the Conifer stock?• Can the personal holding company tax be avoided by having Tree Corporation make an S election?• What tax increase will occur if Chip and Dale personally own the property currently held by Tree Corporation?

Tree Corporation should determine whether the personal holding company (PHC) tax could be avoided by increasing the portion of Tree's income earned from rental real estate activities to permit the rental income to be excluded from the personal holding company income (PHCI). This technique may require that Tree shift asset composition from stocks and bonds to real estate.

If a liquidation occurs, an appraisal of the Conifer stock will be needed. The IRS is unlikely to permit the open transaction doctrine to apply to the Tree Corporation liquidation merely because market quotations for Conifer stock are lacking.Page Ref.: C:6-5 through C:6-9Objective: 2

LO3: Liquidation of a Controlled Subsidiary

1) The liquidation of a subsidiary corporation must be completed within one tax year to receive nonrecognition treatment.Answer: FALSEPage Ref.: C:6-11Objective: 3

2) A subsidiary recognizes no gain or loss on a distribution to a parent corporation owning more the majority of the subsidiary's stock in a complete liquidation.Answer: FALSEPage Ref.: C:6-13Objective: 3

3) A subsidiary must recognize depreciation recapture income when the subsidiary is liquidated into the parent.Answer: FALSEPage Ref.: C:5-14Objective: 3

4) Cowboy Corporation owns 90% of the single class of stock in Doggie Corporation. The other 10% is owned by Miguel, an individual. Cowboy's basis in its Doggie Corporation stock is $100,000 and Miguel's basis is $50,000. Doggie Corporation distributes property having an adjusted basis of $150,000 and an FMV of $500,000 to Cowboy Corporation, and


$60,000 of money to Miguel as a liquidating distribution. Doggie and Cowboy Corporations must recognize gain of:

A) Doggie Cowboy$0 $0

B) Doggie Cowboy$10,000 $0

C) Doggie Cowboy$400,00 $350,000

D) Doggie Cowboy$350,000 $400,000

Answer: AExplanation: The 90% stock ownership by Cowboy meets the Sec. 332 minimum stock ownership rules. Therefore, no gain or loss is recognized by the subsidiary corporation or the parent corporation.Page Ref.: C:6-10Objective: 3

5) Parent Corporation owns 100% of the single class of stock of Subsidiary Corporation. Parent's basis in the Subsidiary stock is $500,000 when Parent completely liquidates Subsidiary Corporation within a single tax year. The Subsidiary Corporation assets have a $700,000 adjusted basis and an $800,000 FMV at liquidation. As a result of the liquidation, Parent must recognize aA) $0 gain.B) $200,000 gain.C) $300,000 gain.D) none of the aboveAnswer: AExplanation: 100% ownership by Parent Corporation of Subsidiary's single class of stock meets the 80% minimum stock ownership requirement of Sec. 332 for nonrecognition of gain or loss.Page Ref.: C:6-10Objective: 3


6) Identify which of the following statements is true.A) A parent corporation cannot liquidate a subsidiary corporation (having but a single class of stock) and avoid recognizing its realized gain unless the parent corporation owns at least 80% of the subsidiary's stock.B) The liquidation of a subsidiary corporation must be completed within one tax year to receive nonrecognition treatment.C) The provisions permitting a tax-free liquidation of a subsidiary corporation apply to both corporate and noncorporate shareholders of the subsidiary.D) All of the above are false.Answer: APage Ref.: C:6-10Objective: 3

7) Carly owns 25% of Base Corporation's single class of stock and Premier Corporation owns the remaining 75%. Carly's basis in the Base stock is $200,000 and Premier Corporation's basis in the Base stock is $600,000. Carly receives property with a $175,000 adjusted basis and a $250,000 FMV and Premier Corporation receives property with a $600,000 adjusted basis and a $750,000 FMV in complete liquidation of Base Corporation. All of Base's cash is used to pay its liabilities. Which of following statements is correct concerning the tax effects of the liquidation?A) Neither Carly nor Premier Corporation will recognize a gain.B) Carly will recognize some gain but Premier Corporation will not recognize any gain.C) Both Carly and Premier will recognize some gain.D) Carly will not recognize any gain but Premier will recognize some gain.Answer: CExplanation: 75% stock ownership by Premier Corporation does not meet the 80% stock ownership minimum of Sec. 332 in order for nonrecognition of gain or loss to occur.Page Ref.: C:6-10Objective: 3

8) When a subsidiary corporation is liquidated into its parent corporation under a formal plan of liquidation, the distributions must take place withinA) a six-month period.B) a 12-month period.C) the current and next tax years.D) the current and next three tax years.Answer: DPage Ref.: C:6-11Objective: 3


9) Parent Corporation for ten years has owned all of the stock of Subsidiary Corporation, which manufactures widgets. Parent's basis in Subsidiary's stock is $500,000. Subsidiary Corporation is insolvent and has no assets to redeem any of the stock that Parent Corporation owns when it liquidates. Nearly all of Subsidiary's gross income during the past five years has come from nonpassive activities. Parent can recognizeA) a $500,000 short-term capital loss.B) a $500,000 long-term capital loss.C) a $500,000 ordinary loss.D) a $500,000 bad debt deduction.Answer: CPage Ref.: C:6-12Objective: 3

10) Ball Corporation owns 80% of Net Corporation's stock and Jack owns the remaining 20% of Net Corporation's stock. Ball's basis in the Net stock is $200,000 and Jack's basis in the Net stock is $100,000. Under a plan of complete liquidation, Ball Corporation receives property with an adjusted basis of $400,000 and an FMV of $800,000 and Jack receives property with an adjusted basis of $50,000 and an FMV of $200,000. Ball and Jack's recognized gains on the liquidation are:

A) Ball Jack$0 $0

B) Ball Jack$0 $100,000

C) Ball Jack$200,000 $50,000

D) Ball Jack$600,000 $100,000

Answer: BPage Ref.: C:6-12 and C:6-13; Example C:6-15Objective: 3


11) Ball Corporation owns 80% of Net Corporation's stock and Jack owns the remaining 20% of Net Corporation's stock. Ball's basis in the Net stock is $200,000 and Jack's basis in the Net stock is $100,000. Under a plan of complete liquidation, Ball Corporation receives property with an adjusted basis of $400,000 and an FMV of $800,000 and Jack receives property with an adjusted basis of $50,000 and an FMV of $200,000. Ball and Jack's bases in the property received are:

A) Ball Jack$800,000 $200,000

B) Ball Jack$400,000 $200,000

C) Ball Jack$400,000 $ 50,000

D) Ball Jack$200,000 $100,000

Answer: BPage Ref.: C:6-13; Example C:6-16Objective: 3

12) Market Corporation owns 100% of Subsidiary Corporation's stock. Market Corporation completely liquidates Subsidiary Corporation, receiving land with a $400,000 adjusted basis and a $500,000 FMV in exchange for Subsidiary stock, which has a $300,000 adjusted basis. Market Corporation has a basis in the land ofA) $300,000.B) $400,000.C) $500,000.D) none of the aboveAnswer: BExplanation: Section 334(b)(1) provides for a carryover basis.Page Ref.: C:6-13Objective: 3


13) Dusty Corporation owns 90% of Palace Corporation's stock and Susan owns the remaining stock. Dusty Corporation's stock basis is $300,000 and Susan's stock basis is $20,000. Under a plan of complete liquidation, Dusty Corporation receives property with a $400,000 adjusted basis and a $540,000 FMV and Susan receives property with a $20,000 adjusted basis and a $60,000 FMV. The bases of the properties are:

A) Dusty Susan$300,000 $20,000

B) Dusty Susan$400,000 $20,000

C) Dusty Susan$400,000 $60,000

D) Dusty Susan$540,000 $60,000

Answer: CPage Ref.: C:6-13Objective: 3

14) Identify which of the following statements is false.A) Minority shareholders involved in a Sec. 332 subsidiary liquidation must recognize a gain or loss under the Sec. 331 general liquidation rules.B) The parent corporation takes a basis in property received when liquidating a subsidiary corporation in a Sec. 332 liquidation equal to its basis to the subsidiary corporation.C) Section 332 is applicable to both the parent corporation and the minority shareholders if they exist.D) Property received by a minority shareholder takes a basis equal to its fair market value.Answer: CPage Ref.: C:6-12Objective: 3


15) Identify which of the following statements is false.A) Liquidating distributions made to minority shareholders in the tax-free liquidation of a controlled subsidiary corporation are treated by the liquidating corporation in the same way as nonliquidating distributions.B) Sec. 337(a) provides that the liquidating corporation recognizes no gain or loss on the distribution of property to the 80% distributee in a complete Sec. 332 liquidation.C) The depreciation recapture provisions in Secs. 1245 and 1250 override the Sec. 337(a) nonrecognition rule if a controlled subsidiary corporation is liquidated into its parent corporation.D) A corporation that distributes the stock of a subsidiary may elect to treat the distribution as a sale of the subsidiary's assets.Answer: CPage Ref.: C:5-14Objective: 3

16) Lake City Corporation owns all the stock in Columbia Corporation. Pursuant to a plan of complete liquidation, Columbia distributes land having a $500,000 FMV and a $200,000 basis to Lake City. Columbia's gain with respect to the distribution will beA) no gain recognized.B) $200,000.C) $300,000.D) $500,000.Answer: APage Ref.: C:6-12 and C:6-13; Example C:6-15Objective: 3

17) Lake City Corporation owns all of the stock in Columbia Corporation. Pursuant to a plan of complete liquidation, Columbia distributes land having a $500,000 FMV and a $200,000 basis to Lake City. Lake City's basis in the land will beA) 0.B) $200,000.C) $500,000.D) cannot be determined from the facts presentedAnswer: BPage Ref.: C:6-13; Example C:6-16Objective: 3

18) The general rule for tax attributes of liquidating corporations isA) they disappear when the liquidation is complete.B) they carry over for five years.C) they disappear only for controlled subsidiary corporations.D) they carry over for an indefinite period of time.Answer: APage Ref.: C:5-14Objective: 3


19) Prime Corporation liquidates its 85%-owned subsidiary Bass Corporation under the provisions of Secs. 332 and 337. Bass Corporation distributes land to its minority shareholder, John, who owns a 15% interest. The property received by John has a $55,000 FMV. The land was used in the Bass Corporation's business and has a $65,000 adjusted basis and is subject to a $10,000 liability, which is assumed by John. John's basis in his stock is $25,000. What gain or loss will John and Bass Corporation recognize on the distribution of the land?

A) John Bass$20,000 gain $0

B) John Bass$20,000 gain $10,000 loss

C) John Bass$30,000 gain $0

D) John Bass$30,000 gain $10,000 loss

Answer: BPage Ref.: C:6-14; Example C:6-18Objective: 3

20) Parent Corporation owns 100% of the stock of Subsidiary Corporation. The adjusted basis of its stock investment is $100,000. A plan of liquidation is adopted. Subsidiary distributes to Parent assets with a $325,000 FMV and a $275,000 adjusted basis. Subsidiary also distributes liabilities in the amount of $40,000. Subsidiary has a $150,000 E&P balance.a) What is the amount and character of Subsidiary Corporation's recognized gain or loss on the distribution?b) What is the amount and character of Parent Corporation's recognized gain or loss on the redemption of the Subsidiary stock?c) What basis does Parent take in the assets?d) What happens to parent Corporation's basis in the Subsidiary stock and to Subsidiary's tax attributes?Answer: a) $325,000 - $275,000 = $50,000 realized gain, but no recognized gain (Sec. 337).b) $325,000 - $40,000 liabilities - $100,000 = $185,000 realized gain, but no recognized gain (Sec. 332).c) $275,000 carryover basis.d) The basis for the Parent stock disappears and is replaced by the basis of each of the individual assets. Subsidiary's E&P balance carries over to Parent.Page Ref.: C:6-10 through C:6-14Objective: 3


21) Parent Corporation owns 80% of the stock of an insolvent subsidiary corporation. Vic owns the remaining 20% of the stock. The courts determine the subsidiary to be bankrupt, and the shareholders receive nothing for their investment. How do they report their losses?Answer: The liquidation will not qualify for nonrecognition treatment under Sec. 332,because no liquidating distribution was made to the corporate shareholder. Parent Corporation recognizes an ordinary loss for its investment in Subsidiary Corporation under the special Sec. 165(g)(3) worthless security rules. Vic recognizes a capital loss to the extent of his investment under the Sec. 331 general liquidation rules. Vic may recognize an ordinary loss under the Sec. 1244 rules if its requirements are satisfied.Page Ref.: C:6-11 and C:6-12Objective: 3

22) What basis do both the parent and minority shareholders take in the assets received in a Sec. 332 liquidation?Answer: Since the parent recognizes no gain or loss in the transaction, it takes a carryover basis. Since the minority shareholders have a taxable transaction, they take an FMV basis for the assets received in the transaction.Page Ref.: C:6-12Objective: 3

23) What attributes of a controlled subsidiary corporation are carried over to the parent when the subsidiary is liquidated?Answer: NOL carryovers, earnings and profits, capital loss carryovers, and the general business and other tax credit carryovers are carried over to the parent when a controlled subsidiary is liquidated. The carryover amount is determined as of the close of the day on which the distribution of all the subsidiary corporation's property is completed.Page Ref.: C:5-14Objective: 3

24) In a Sec. 332 liquidation, can a subsidiary corporation recognize losses on distributions to either the parent corporation or minority shareholders?Answer: No. Section 332 liquidations are an exception to the general rule that losses are recognized by the liquidating corporation. Losses are not recognized on distributions to either the parent corporation or the minority shareholders.Page Ref.: C:6-10Objective: 3

25) In a Sec. 332 liquidation, what bases do both the parent and minority shareholders take in the assets received?Answer: Because no gain/loss is recognized by the parent corporation, the parent corporation takes a carryover basis in its assets. However, since the minority shareholders are involved in a taxable exchange, the minority shareholders take an FMV basis in their assets.Page Ref.: C:6-10Objective: 3


26) What are the differences, if any, in the tax rules applying to distributions made to a parent corporation and a minority shareholder when a controlled corporation liquidates?Answer: Shareholders receiving liquidating distributions generally recognize gain or loss under Sec. 331 on the exchange of their stock interest. A special rule applies to the parent corporation when a controlled subsidiary corporation is liquidated. The parent corporation (80% distributee) recognizes neither gain nor loss when it receives a liquidating distribution (Sec. 332). A minority shareholder on the other hand recognizes gain or loss when receiving the distribution under the general Sec. 331 rules. Two exceptions to the general Sec. 336 gain or loss recognition rules apply to property distributions made by a controlled subsidiary corporation. First, under Sec. 337 the subsidiary corporation does not recognize gain or loss when it makes a liquidating distribution to an 80% distributee corporation. Second, under Sec. 336(d)(3) the subsidiary corporation recognizes gain (but not loss) when it makes a liquidating distribution to a minority shareholder.Page Ref.: C:6-11 through C:6-13Objective: 3

LO4: Special Reporting Issues

1) Liquidating expenses are generally deducted as ordinary and necessary business expenses.Answer: TRUEPage Ref.: C:6-16Objective: 4

2) Sandy, a cash method of accounting taxpayer, has a basis of $46,000 in her 500 shares of Newt Corporation stock. She receives the following distributions as part of Newt's plan of liquidation.

March 31, 2007 $10,000July 15, 2007 10,000November 15, 2007 10,000January 15, 2008 10,000

The amount of the final distribution is not known on December 31, 2007. What are the tax consequences of the distributions?A) Sandy will recognize a loss of $4,500 in 2007 and a $1,500 loss in 2008.B) Sandy will recognize the entire loss in 2007.C) Sandy will recognize the entire loss in 2008.D) None of the above is correct.Answer: CPage Ref.: C:6-16Objective: 4


3) Greg, a cash method of accounting taxpayer, owns 100 shares of Parker Corporation stock with a basis of $20,000. Greg receives two liquidating distributions of $8,000 on March 3 of last year, and $8,000 on August 8 of this year. The amount of the second distribution is not known until June 15 of this year. Greg recognizes A) a gain of $8,000 last year and a loss of $12,000 this year.B) a loss of $2,000 last year and a loss of $2,000 this year.C) no loss last year and a $4,000 loss this year.D) none of the aboveAnswer: CExplanation: The shareholder basis is recovered first and the recognition of gain occurs only after the basis has been recovered in a series of partially liquidating distributions. No loss is generally recognized until the final liquidating distribution has been received.Page Ref.: C:6-15; Example C:6-20Objective: 4

4) Barbara owns 100 shares of Bond Corporation stock with a basis of $40,000. Barbara receives two liquidating distributions, including $16,000 paid last year and $20,000 paid in the current year. An additional distribution of an undetermined amount is expected next year. On last year's tax return, Barbara can recognize a loss ofA) $0.B) $1,000.C) $4,000.D) $14,000.Answer: AExplanation: The shareholder's basis is recovered first and the recognition of gain occurs only after the basis has been recovered in a series of partially liquidating distributions.Page Ref.: C:6-15; Example C:6-20Objective: 4

5) Hope Corporation was liquidated four years ago. Teresa reported a $40,000 long-term capital gain due to the liquidation on her individual tax return. This year, Teresa pays $6,000 as part of the settlement of a lawsuit against Hope. Due to the $6,000 payment, Teresa recognizes aA) $6,000 long-term capital loss.B) $6,000 short-term capital loss.C) $6,000 ordinary loss.D) none of the aboveAnswer: APage Ref.: C:6-15 and C:6-16; Example C:6-21Objective: 4


6) Key Corporation distributes a patent with an indeterminable value to Gary as part of a plan of complete liquidation. In addition, Gary receives $40,000 cash and land with a $70,000 FMV and a $30,000 adjusted basis. Gary's basis in the Key stock (a capital asset) surrendered is $120,000. If Gary relies on the open transaction doctrine, at the liquidation date he must recognize aA) $0 gain.B) $10,000 capital loss.C) $30,000 capital loss.D) $70,000 capital gain.Answer: AExplanation: The liquidating distribution is an open transaction. No gain or loss is recognized since the amount received ($110,000) is less than Gary's $120,000 basis in his stock.Page Ref.: C:6-16Objective: 4

7) During 2013, Track Corporation distributes property to Cindy as part of a complete liquidation. Property included in the distribution is $30,000 in cash, land with a $40,000 adjusted basis and a $60,000 FMV, and a copyright without an ascertainable FMV and having a zero basis. The first payment to Cindy of $8,000 for use of the copyrighted property occurs in 2014. Cindy has a basis in the Track stock of $95,000 immediately preceding the liquidation. The minimum amount of gain that Cindy must recognize is aA) $3,000 gain in 2014.B) $0 gain in 2013.C) $3,000 gain in 2013, which is reported on an amended current-year tax return that is filed in 2014.D) none of the above.Answer: BExplanation: No gain is recognized since the copyright does not have an ascertainable FMV and Cindy can apparently rely on the open transaction doctrine to determine her gain or loss. Cindy has a $5,000 [($30,000 + $60,000) - $95,000] unrecovered basis immediately after the liquidation. The receipt of the first payment of $8,000 results in a $3,000 ($8,000 - $5,000) gain being recognized in the following year.Page Ref.: C:6-16Objective: 4

8) Identify which of the following statements is false.A) An individual taxpayer, who is assessed an additional payment of money based on stock ownership in a corporation whose stock is redeemed in a complete liquidation, may recognize a capital loss to the extent of the additional assessment.B) The open transaction doctrine defers the shareholder's gain or loss from a liquidation until the assets can be valued by sale or collection.C) The open transaction doctrine as applied to complete corporate liquidations refers to the numerous planning alternatives available when liquidating a corporation.D) The IRS asserts that the open transaction doctrine should be used only in extraordinary circumstances.Answer: CPage Ref.: C:6-16Objective: 4


9) Identify which of the following statements is true.A) Upon liquidation, any capitalized expenditures unamortized at the time of liquidation should be deducted if they have no further value to the corporation.B) Shareholders who receive an installment obligation as part of their liquidating distribution ordinarily report the FMV of their obligation as part of the consideration received to calculate the amount of recognized gain or loss.C) A liquidating corporation treats expenses associated with selling its property as an offset against the sales proceeds.D) All the above are true.Answer: DPage Ref.: C:6-16 and C:6-17Objective: 4

10) Homewood Corporation adopts a plan of liquidation on June 15 and shortly thereafter sells a parcel of land on which it realizes a $50,000 gain (excluding the effects of a $5,000 sales commission). Homewood pays its legal counsel $2,000 to draft the plan of liquidation. The accountant fees for the liquidation are $1,000, which are also paid during the year. What is Homewood Corporation's realized gain on the sale of land and deductible liquidation expenses?

A)

GainLiquidation Expenses

$45,000 $3,000

B)


$50,000 $2,000

C)


$55,000 $3,000

D)


$50,000 $1,000

Answer: APage Ref.: C:6-16; Example C:6-22Objective: 4


11) Why should a corporation that is 100% owned by another corporation be treated differently when it liquidates than a corporation that is 100% owned by an individual?Answer: A corporation that is 100% owned by another corporation can file a consolidated tax return. As a result, the parent and its subsidiary are treated as a single entity. This result is the same as if the subsidiary were one of a number of divisions of a single corporation. An extension of the single entity concept is that a subsidiary corporation can be liquidated tax-free into its parent corporation. An individual and his corporation are treated as two separate tax entities. As separate entities, nonliquidating distributions are taxable. The same principle applies to liquidating distributions.Page Ref.: C:6-11 through C:6-13Objective: 4

12) Jack has a basis of $36,000 in his 1,000 shares of Acorn Corporation stock (a capital asset). The stock was acquired three years ago. He receives the following distributions as part of a plan of liquidation of Acorn Corporation:

Date AmountMarch 31 of 2009 $10,000July 15 of 2009 10,000November 15 of 2010 10,000January 15 of 2010 10,000

What are the amount and character of the gain or loss that Jack will recognize during 2009? During 2010?Answer: Because Jack's $36,000 basis has not been recovered by the end of 2009, Jack will have no recognized gain in 2009. His unrecovered basis at the end of 2009 is $6,000 ($36,000 - $30,000). He will recognize a $4,000 gain in 2010 ($10,000 - $6,000). The gain will be a long-term capital gain.Page Ref.: C:6-15Objective: 4

13) Penny, a cash-basis taxpayer, reported a $15,000 long-term capital gain on the exchange of her Midwest Corporation stock when the corporation liquidated in 2012. Midwest subsequently lost a lawsuit and Penny paid an additional $3,000 in 2014 as her part of the settlement. What are the tax consequences to Penny in 2014 of the $3,000 additional payment she made?Answer: The $3,000 that she paid personally is treated in 2014 as a long-term capital loss.Page Ref.: C:6-15Objective: 4

14) New York Corporation adopts a plan of liquidation on March 15 and shortly thereafter sells a parcel of land on which it realizes a $15,000 gain (excluding the effects of a $2,000 sales commission). New York pays its legal counsel $500 to draft the plan of liquidation. All of New York's remaining properties are distributed to its shareholders on September 15. What are the tax consequences to New York on the land sale?Answer: New York has a recognized gain of $13,000 ($15,000 - $2,000) and a $500 liquidation expense for legal counsel on its current-year income tax return.Page Ref.: C:6-16; Example C:6-22Objective: 4


15) What are the tax consequences of a cash-method shareholder, subsequent to a liquidation, if obligated to pay a contingent liability of the liquidated corporation?Answer: No amendment is made to the prior year's tax return. The additional payment results in a loss recognized in the year of payment. The character of the loss is dependent on the nature of the gain or loss recognized by the shareholder in the year of liquidation.Page Ref.: C:6-15Objective: 4

16) What is the IRS's position regarding whether a liquidating transaction will be considered open or closed?Answer: The IRS's position is that the open transaction method may be used only in unusual circumstances. The IRS prefers the closed transaction alternative. In a closed transaction, gain or loss is determined based on the FMV of the property distributed on the distribution date. This FMV amount becomes the property's basis. At the time the property is sold, collected, or its value is definitely determined, gain or loss is computed by comparing the property's value at that time to its adjusted basis.Page Ref.: C:6-16Objective: 4

LO5: Recognition of Gain or Loss When Property is Distributed in Retirement of Debt

1) When a liquidating corporation pays off an unsecured debt obligation,A) the corporation recognizes no gain or loss if it uses appreciated property.B) the corporation recognizes no gain or loss if it uses cash.C) the corporation recognizes any gains but not losses realized.D) the corporation recognizes losses but not gains realized.Answer: BPage Ref.: C:6-17 and C:6-18Objective: 5

2) Identify which of the following statements is true.A) The Sec. 332 nonrecognition rules apply to the parent corporation when a subsidiary corporation transfers property to the parent corporation in payment of the subsidiary's debt obligation.B) A subsidiary corporation is prevented from recognizing gain or loss when transferring property to its parent corporation in satisfaction of an indebtedness it owes to the parent corporation as part of its complete liquidation.C) Nonrecognition of gain or loss rules apply to a subsidiary corporation when, pursuant to its complete liquidation, the subsidiary transfers property to a third-party creditor.D) All of the above are false.Answer: BPage Ref.: C:6-17 and C:6-18Objective: 5


3) Parent Corporation owns all of Subsidiary Corporation's stock. In addition, Parent Corporation owns $100,000 (face amount and basis) of Subsidiary Corporation's bonds. When Subsidiary Corporation is completely liquidated, it distributes property with a $70,000 adjusted basis and a $100,000 FMV to Parent Corporation in redemption of the Subsidiary Corporation bonds. Following the liquidation, Parent Corporation will have a basis in the Subsidiary Corporation property received for the bonds ofA) $0.B) $70,000.C) $100,000.D) none of the aboveAnswer: BExplanation: Parent takes a carryover basis from Subsidiary Corporation's books for the property it receives in cancellation of the bonds.Page Ref.: C:6-18; Example C:6-23Objective: 5

4) Santa Fe Corporation adopts a plan of liquidation late in the current tax year in which it expects to earn $100,000 profits from its operating activities. Santa Fe's operating activities are discontinued before the end of the year. Pursuant to the liquidation, it distributes assets, which result in the recognition of $30,000 of ordinary losses. Santa Fe also distributes assets that have appreciated in value, which results in the recognition of $30,000 of ordinary gains. Generally, Santa Fe Corporation should distributeA) the $30,000 of ordinary loss property in the current year and the $30,000 of ordinary gain property next year.B) both the ordinary loss and gain properties this year.C) both the ordinary losses and gains properties next year.D) the $30,000 of ordinary gain property in the current year and the $30,000 of ordinary loss property next year.Answer: APage Ref.: C:6-18; Example C:6-24Objective: 6

LO6: Tax Planning Considerations

1) Parent Corporation owns 70% of Sam Corporation's single class of stock. This year, Parent Corporation purchases for cash the remaining 30% of Sam Corporation's stock from four individual investors pursuant to a tender offer. A plan of liquidation is approved by Sam Corporation's shareholders during the last month of this year, and Sam Corporation's assets are distributed by year-end to Parent Corporation in exchange for all of Sam's outstanding stock. Parent Corporation shouldA) not recognize any gains and losses on the redemption.B) recognize gains and losses on the redemption.C) recognize gains but not losses on the redemption.D) recognize losses but not gains on the redemption.Answer: APage Ref.: C:6-19; Example C:6-25Objective: 6


2) If a liquidating subsidiary corporation primarily has loss property to distribute, the parent corporation shouldA) follow Sec. 332 rules.B) avoid Sec. 332 rules.C) follow Sec. 332 rules but avoid Sec. 337.D) none of the aboveAnswer: BPage Ref.: C:5-20Objective: 6

3) What are the tax consequences to Parent Corporation when Parent Corporation, which owns 75% of Subsidiary Corporation's single class of stock, purchases for cash the remaining 25% of the Subsidiary stock from three individual shareholders pursuant to a tender offer? Three months later as part of an approved plan of liquidation, Subsidiary's assets all distributed to Parent Corporation in exchange for all of Subsidiary's outstanding stock.Answer: Parent Corporation recognizes no gain or loss on the redemption of its Subsidiary stock because all of the Sec. 332 requirements have been satisfied prior to the adoption of the plan of liquidation.Page Ref.: C:6-19Objective: 6

4) For that following set of facts, what are the tax consequences to Parent Corporation, Subsidiary Corporation, and a Subsidiary Corporation shareholder, Melisa? Parent Corporation owns 80% of Subsidiary Corporation's stock. Melisa owns the remaining 20% of the Subsidiary stock. Parent and Melisa's stock have adjusted bases of $100,000 and $25,000, respectively, for their Subsidiary stock. Subsidiary distributes land having a $125,000 adjusted basis and a $200,000 FMV to Parent and $50,000 in cash to Melisa.Answer: Parent recognizes no gain on the liquidation and takes a $125,000 basis in the land. Subsidiary recognizes no gain or loss on the distribution of the land or the cash. Melisa recognizes a $25,000 ($50,000 - $25,000) capital gain on the receipt of the money.Page Ref.: C:6-19Objective: 6


5) Parent Corporation, which operates an electric utility, created a 100%-owned corporation, Subsidiary that built and managed an office building. Assume the two corporations have filed separate tax returns for a number of years. The utility occupied two floors of the office building, and Subsidiary offered the other ten floors for lease. Only 25% of the total rental space was leased because of the high crime rate in the area surrounding the building. Rental income was insufficient to cover the mortgage payments, and Subsidiary filed for bankruptcy because of the poor prospects. Subsidiary's assets were taken over by the mortgage lender. Parent lost its entire $500,000 investment. At the time Subsidiary was liquidated, another $100,000 of debts remained unpaid for the general creditors, which included a $35,000 account payable to Parent. What tax issues should Parent and Subsidiary consider with respect to the bankruptcy and liquidation of Subsidiary?Answer: The managements of Parent and Subsidiary should consider the following tax issues:

• What gain or loss does Parent Corporation recognize on the transfer of its remaining property to the mortgage lender?• Does Subsidiary Corporation have to recognize cancellation of indebtedness income from not having repaid its debts?• Does Subsidiary Corporation have to file a corporate tax return for the portion of the final tax year that it is in existence? If so, what income and expenses are included in the return?• Can Subsidiary Corporation deduct the liquidation expenses on its final tax return?• What is the amount and character of the loss that Parent Corporation recognizes upon surrendering its Subsidiary stock? Upon not being repaid for the open account indebtedness?• What happens to Subsidiary Corporation's tax attributes?

Because Parent Corporation received nothing for its investment in Subsidiary Corporation, it can claim a worthless security loss for the $500,000 investment. This loss should be an ordinary loss under Sec. 165(g)(3). Subsidiary's $35,000 debt to Parent should be deductible as a bad debt under Sec. 166. Because corporations do not have a distinction between business and nonbusiness debts, Subsidiary can claim an ordinary loss deduction for the bad debt in its final tax return.Page Ref.: C:6-10 through C:6-14 and C:6-16Objective: 3

LO7: Compliance and Procedural Considerations

1) A corporation is required to file Form 966 within 30 days after the adoption of a plan of liquidation.Answer: TRUEPage Ref.: C:5-20Objective: 7

2) A plan of liquidation must be reduced to writing in order to be accepted by the Internal Revenue Service.Answer: FALSEPage Ref.: C:6-21Objective: 7


3) A liquidation must be reported to the Internal Revenue Service on Form 966A) within 60 days of the adoption of a plan of liquidation.B) that is filed with the national IRS office.C) whether the shareholders' realized gain is recognized or not.D) by the shareholders.Answer: CPage Ref.: C:5-20Objective: 7

4) Identify which of the following statements is false.A) A corporation must file an information return with the Internal Revenue Service within thirty days of adopting a resolution to liquidate.B) The adoption of a formal plan of liquidation can provide additional benefits under tax laws to the corporation and its shareholders.C) A plan of liquidation must be produced in writing in order to be accepted by the Internal Revenue Service.D) The adoption of a plan of liquidation permits a parent corporation a three-year time period to carry out the complete liquidation of its subsidiary.Answer: CPage Ref.: C:6-21Objective: 7

5) A Sec. 332 liquidation requires a complete statement be filed with the distributee's tax returnA) when a liquidating distribution is received.B) when the liquidation plan is adopted.C) when the liquidation is compiled.D) No statement is required with the return.Answer: APage Ref.: C:6-21Objective: 7

6) A plan of liquidation A) must be written.B) details the steps to be undertaken in carrying out the liquidation.C) must be a formal plan.D) must be completed in one year.Answer: BPage Ref.: C:6-21Objective: 7


chapter c6

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