Page 271 - DCOM508_CORPORATE_TAX_PLANNING

Corporate Tax Planning

Notes 15. The decision to wind up a company is often taken when the company is
incurring…………..
16. The appointment of a liquidator does not necessarily mean the ……………..of a trade.

Case Study Determining Tax Consequences of Corporate Liquidation
to the Shareholders
nder Sec. 331, a liquidating distribution is considered to be full payment in exchange
for the shareholder’s stock, rather than a dividend distribution, to the extent of the
Ucorporation’s Earnings and Profi ts (E&P). The shareholders generally recognise
gain (or loss) in an amount equal to the difference between the Fair Market Value (FMV)
of the assets received (whether they are cash, other property, or both) and the adjusted
basis of the stock surrendered. If the stock is a capital asset in the shareholder’s hands, the
transaction qualifies for capital gain or loss treatment.

If the corporation sells its assets and distributes the sales proceeds, shareholders recognise
gain or loss under Sec. 331 when they receive the liquidation proceeds in exchange for
their stock. If the corporation distributes its assets for later sale by the shareholders, the
assets generally “come out” of the corporation with a basis equal to FMV (and with the
related recognition of gain or loss under Sec. 331 for the difference between the FMV and
the shareholder’s basis in the stock). As a result, the tax consequences of a subsequent sale
of the assets by the shareholder should be minimal.
The result of these rules is double taxation. The corporation is treated as selling the
distributed assets for FMV to its shareholders, with the resulting corporate-level tax
consequences. Then, the shareholders are treated as exchanging their stock for the FMV
of the assets distributed in complete liquidation, with the resulting gains or losses at the
shareholder level.
Recognising Capital Gains Rather Than Dividends
When determining whether a closely held corporation should be liquidated, the tax
consequences to the shareholders should be considered. If the stock is a capital asset in
the hands of the shareholder, the shareholder has a capital gain or loss on the exchange.
The maximum tax rate for both long-term capital gains (realised after May 5, 2003, and
before 2013) and dividends (for tax years beginning after 2002 and before 2013) is 15%. For
taxpayers in the 10% or 15% ordinary tax brackets, there is no tax on most long-term capital
gains and dividends realised after 2009 and before 2013. Shareholders may want to evaluate
the sale or disposal of stock by the end of 2012 to take advantage of the 15% dividend tax
rate, lower individual income tax rates, and lower capital gain tax rates set to expire on
Dec. 31, 2012. Guidance on the tax treatment of these items in 2013 and subsequent tax
years is uncertain, so practitioners should watch for future legislation.
Shareholders that do not have a strong preference on whether distributions in 2012 are
taxed as dividends or capital gain/loss may prefer sale or exchange (capital) treatment in
2012 if they:
1. Have capital losses or capital loss carry forwards, since Sec. 301 dividend income
cannot be used to offset capital losses;
2. Have basis in stock that can used to offset the distribution income (if the basis is
higher than the amount of the distribution, the shareholder could potentially report
a loss); or
Contd...

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