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Unit 11: Tax Planning for Liquidation

11.3.2 Concerns of the Liquidating Corporation Notes

In theory, the tax consequences of liquidation should be the same whether the corporation sells
assets to a third party and then distributes the proceeds to its shareholders or simply distributes
all assets in liquidation.

(i) Valuation of assets: The deemed sale created by a distribution may produce valuation
problem not present in an actual sale to a third-party purchaser. Because the burden of
proof of valuation is on the taxpayer, the corporation should retain a qualified appraiser to

defend the value assigned to the assets. Obtaining an appropriate value for individual assets
is not the only concern for the liquidating corporation. Since a liquidating distribution is a
deemed sale of all corporate property, the IRS may seek to value the company as a going
concern, if a shareholder continues the business as a sole proprietorship, proprietorship,
with a result in valuation in excess of the aggregate value of the company’s identifi able
assets. In this regard, it is necessary to consider the applicability of Sec. 1060.

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Caution If Sec. 1060 applies to the deemed sale, it is possible that an allocation to goodwill
or going concern value would be required, increasing the corporate and shareholder tax
burden.
(ii) Rules and applicability of Sec. 1060: Under pre-TRA law, there existed a competing
interest between buyers and sellers in the allocation of purchase price in asset purchases.

Sellers generally benefited from a larger allocation to capital assets, including goodwill
or going concern value, because of preferential capital gains taxation. Buyers generally
benefi ted from a larger allocation to depreciable tangible assets or amortisable intangible
assets, with goodwill or going concern allocations avoided to the extent possible. This

adverse interest between the buyer and seller gave the allocation of a fixed purchase price
to individual assets a measure of credibility. When the TRA eliminated preferential capital
gains taxation, sellers could be expected to be indifferent to how a lump-sum sales price
was allocated, since this allocation generally no longer had an effect on their tax liability.
As a result, Congress was concerned about potential abuses in purchase price allocations,
with particular emphasis on the assignment of value to goodwill or going concern value.
Its response was to enact Sec. 1060, which mandates the use of the “residual method” of
valuation to asset acquisitions.

Notes Sec. 1060 applies to any “applicable asset acquisition,” which is defi ned as any
direct or indirect transfer of assets that constitute a trade or business in the hands of either
the seller or the purchaser, and with respect to which the transferee’s basis is determined
solely by reference to the consideration paid for the assets. The regulations issued under
Sec. 1060 define a group of assets to constitute a trade or business if — the use of the assets

would constitute an active trade or business for purposes of Sec. 355; or the character of the
assets is such that goodwill or going concern value could attach to those assets.

Sec. 1060(a) provides that a lump-sum purchase price will be allocated among specifi c
assets using the residual method approach prescribed in Sec. 338(b). Under the Sec. 338
temporary regulations, the residual method allocates the purchase price to identifi able
tangible and intangible assets, up to their FMV, with any remainder allocated to goodwill
or going concern value.

(iii) Disallowance of losses: Losses are disallowed to the liquidating corporation on the
distribution of any property to a related person if the distribution is not pro rata or
consists of “disqualified property.” For this purpose a related party generally refers to any

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