Tax treatment loss liquidating distributions
As stated in Taxation of Limited Liability Companies and Partnerships, limited liability companies are taxed as partnerships by default.This discussion of the tax consequences of contributions to partnerships will also apply to limited liability companies unless the limited liability company has elected to be taxed as a corporation.The partnership agreement determines the allocation of these items. If the partnership agreement is silent, these items are allocated in accordance with the partnership interests. If the partnership agreement allocates partnership items among the partners, the allocation is respected as long as one of the following is true: If an allocation does not meet one of these requirements, the allocation of income, gain, loss, deduction, or credit is reallocated in accordance with the partner’s interest in the partnership. Special rules apply to allocations of property with built-in gain and loss. Important Note: The rules governing substantial economic effect are complex and must be given special consideration if the partnership agreement or operating agreement provides for allocations other than in accordance with each partner’s interest in the partnership.Unformatted text preview: COMPREHENSIVE VOLUME--CHAPTER 20--CORPORATIONS: DISTRIBUTIONS IN COMPLETE LIQUIDATION AND AN OVERVIEW OF REORGANIZATIONS Student: ___________________________________________________________________________ 1. A corporation generally will recognize gain or loss on a liquidating distribution of installment notes to its shareholders. Section 332 can apply to a parent-subsidiary liquidation even if the subsidiary corporation is insolvent on the date of the liquidation. If a liquidation qualifies under § 332, any minority shareholder will recognize gain or loss equal to the difference between the fair market value of assets received and the basis of the shareholder’s stock. A subsidiary corporation is liquidated at a time when it is indebted to its parent corporation.When a company has more liabilities than assets, equity is negative and no liquidating distribution is made at all.
The Internal Revenue Code uses four tests to make this distinction: To prevent gamesmanship among related parties, Congress has added another layer of rules that must be analyzed to determine if a distribution is a redemption.The rules governing distributions from C corporations differ from the rules that apply to distributions from S corporations.To the extent that a distribution is made from the corporation’s earnings and profits, it is taxed to the shareholder as a dividend. The portion of the distribution that is not considered a dividend is applied first to reduce the shareholder’s basis in the corporation’s stock. Any remaining portion is treated as gain from the sale or exchange of property (capital gain). Important Note: If a shareholder assumes a liability or takes property subject to a liability, the amount of the distribution is reduced by the amount of the liability. Special rules also apply at the corporate level. Special rules apply to distributions to a shareholder in exchange for the shareholder’s stock (redemptions).Legal dissolution under state law is required for a liquidation to be complete for tax purposes. One similarity between the tax treatment accorded liquidating and nonliquidating distributions is with respect to a shareholder’s basis in property received in such distributions. The subsidiary corporation distributes property to the parent corporation in satisfaction of the indebtedness.For each type of distribution, the shareholder’s basis is the property’s fair market value on the date of distribution. As a general rule, a liquidating corporation recognizes gains but not losses on the distribution of property in complete liquidation. Liquidation expenses incurred by a corporation are generally deductible as § 162 trade or business expenses. The related-party loss limitation applies to distributions to related parties and either the distribution is pro rata or the property distributed is disqualified property. The built-in loss limitation in a complete liquidation does not apply to losses attributable to a decline in a property’s fair market value after its transfer to the corporation. The related-party loss limitation in a complete liquidation applies only to distributions of property while the built-in loss limitation can apply to a distribution or sale of property. Pursuant to a liquidation, Coral Corporation distributes to Lucinda, a shareholder, land (basis of ,000, fair market value of 0,000). If the liquidation is governed by § 332, neither the subsidiary nor the parent recognize gain or loss on the transfer of property in satisfaction of indebtedness. Brown Corporation purchased 85% of the stock of Green Corporation five years ago for 0,000.