Page 267 - DCOM508_CORPORATE_TAX_PLANNING

Corporate Tax Planning

Notes shareholder owning, directly or indirectly, more than 50% in value of the outstanding stock
of the liquidating corporation. Disqualified property includes any property acquired by

the liquidating corporation in a Sec. 351 transaction or as a contribution to capital during

the five-year period ending on the date of distribution.
Losses may also the limited for certain distributions or sale or exchange transactions with a
tax-avoidance motive. This limitation is to prevent shareholders from shifting losses to the
corporation by contributing property with a built-in loss, with the objective of recognising
the loss on a sale or distribution in liquidation. Any built-in loss cannot be recognised
with respect to any property contributed in a Sec. 351 transaction or as a contribution to
capital, if the contribution had a tax-avoidance motive. Any decline in value occurring
after the contribution will result in a deductible loss. If the contribution occurs within two
years of the adoption date of a plan of liquidation, the transaction is presumed to have a
tax-avoidance motive.

Did u know? The loss disallowance rule may be diffi cult to apply for two reasons:
1. Determining the allowed loss requires knowing the asset’s FMV at the date of
contribution. It is unlikely the taxpayer had the foresight to appraise the asset at that
time, creating significant potential for controversy.

2. The adoption date of a plan of liquidation is subjective. The taxpayer’s purposes may
be served by delaying the adoption of a formal plan to a date more than two years
from the contribution of the asset. The IRS would then be expected to argue that an
informal plan had been previously adopted.
(iv) Using capital losses at the corporate level: Since capital losses of a corporation are allowed
to offset only capital gains, it is particularly important that the liquidating corporation

generate sufficient capital or net Sec. 1231 gains to offset capital loss carry forwards and
capital losses arising in the year of liquidation. Otherwise, all tax attributes disappear on
liquidation, and no tax benefit will ever be realised from the capital losses.

On the sale or distribution of Sec. 1245 property, any recognised gain will be ordinary
income up to the amount of depreciation claimed. Sec. 1250 requires the corporation to
recognise ordinary income to the extent that depreciation claimed under the accelerated
method exceeds the amount that would have been claimed using the straight line method.
If real property is sold or distributed in liquidation, Sec. 291(a) requires the corporation
to recognise ordinary income in an amount equal to 20% of the excess (if any) of the
amount treated as Sec. 1245 recapture if that section had applied, over the amount treated
as Sec. 1250 recapture. These recapture provisions may limit the ability of the liquidated
corporation to offset capital losses.

11.3.3 Tax Treatment to the Shareholder

Various treatments of tax to shareholder are as follows:
(i) Character of gain or loss: The character of gain or loss recognised by the shareholder
from a liquidating distribution is generally capital in nature. If the liquidated corporation

meets the definition of a collapsible corporation, any shareholder gain will be considered
ordinary income. A collapsible corporation basically entails a distribution of property by
a corporation to its shareholders before the corporation realises a substantial part of the
taxable income to be derived from such property. Following the TRA, collapsibility is
unlikely to be an issue because all corporate level income is recognised.
(ii) Gain deferral through the open-transaction doctrine: A corporation may make a series
of distributions in the course of a complete liquidation extending over several tax years.

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