General
Liquidation occurs when a corporation winds up its affirs, pays off debts, and makes distributions of the remainind assets to the shareholders. The corporation recognizes the gains and losses upon distribution to its shareholders, and so does the shareholder.
For corporations, to determine the gain and loss, look at the fair market value of the asset and subtract by the adjusted bases. This procedure is done for each asset individually. These losses and gains are reported on the corporation’s final tax return. Shareholders then receive the net of any remainder after the corporate tax is paid.
For shareholders, the fair market value minus the basis in stock results in a capital gain or loss that is recognized. After the distribution, shareholder’s stock ownership is terminated and they receive a basis the fair market value of the assets received.
Subsidiary Liquidation
If a subsidiary is liquidating, they do not recognize gains or losses. Instead, they are liquidated into the parent corporation tax-free to both the subsidiary and parent. The parent orgainzation then takes the liabilities and assets with carryover basis (Earnings and Profit—E&P—can carryover too).
To qualify for the “exception,” (1) the parent organization must own at least 80% of voting stock and the value of the stock, (2) the subsidiary must be solvent (meaning the assets are greater than the liabilities), and (3) the subsidiary must distribute all the assets within three years.
However, if there remains minority shareholders (meaning owning less than 20% as a group), they still receive distributions. Distributions to minority shareholders means the corporation will recognize gains but not losses. These minority shareholders do recognize both gain and loss (calculated by the fair market value of property received minus the stock basis. The new basis is the fair market value of the assets received).
Corporate Acquisitions
This is a Merger & Acquisition (M&A) transaction. The most common acquisition is stock or asset (stock even more so). For stock aquisitions, the buyer purchases the target’s stock directly from the target’s shareholders and becomes the new owner of the target. The target itself continues to exist. For an asset acquisition, the buyer purchases the target’s assets directly from the target who subsequently liquidates and distrubes the sale proceeds to the shareholders. After liquidation, thte target no longer exists.
Stock Acquisitions
A stock acquisition is a transaction between the buyer and the target’s shareholders, not the target. The target’s shareholders then recognize a gain on the sale of their stock to the buyer. This is calculated by the fair market value of the assets received from the buyer minus the baasis in the target’s stock. As a result of the transaction, the buyer’s basis in the target’s stock is the fair market value (the purchase price). Additionally, the target still exists, but not as a subsidiary of the buyer.
Asset Acquisitions
§ 388 Election
A stock acquisition could be treated as an asset transaction if the election is made by the 15th day of the 9th month after the qualifying transaction occured. A qualified transaction occured if the corporation acquires 80% of the stock within twelve months.
However, this typoe of transaction is rarely done because the seller is deemed to have sold its assets for the fair market value on day one and then repurchases the assets on day two. The consequence of this is there is a large gain after the purchase and a decrease in the basis on the repurchase (a higher basis is recognized further down the road). Basically, the tax burden is going to hurt in a very short period of time.
Tax-Free Acquisitions (Reorganizations)
The purpose of a tax-free acquisition is to avoid recognizing teh gain or loss in a transactions. To qualify, (1) the purchase must be for a business purchase unrelated to saving on taxes, (2) the buyer must use their stock as consideration for the purchase (i.e., the target’s shareholders become shareholders of the buyer), and (3) the buyer must continue a significant portion of the target’s business after the transaction.
Consequently, there is no gain or loss recognized by any party. Further, the buyer’s basis in stock or assets is carried over from the target. Finally, boot occurs if the buyer uses anything other than stock for consideration. Boot is recognized as a gain.
Acquisitive Reorganization
There are seven different types of reorganizations:
- Type A – Merger
- Type B – Stock for Stock Acquisition (most popular). In this transaction, the buyer exchanges shares for the shares of the target. As a result, the target is a subsidiary of the target.
- Type C – Stock for Asset Acquisition. Here, the buyer exchanges shares for the target’s assets. After the transaction, the target will liquidate and distribute the stock to its shareholders (thus becoming shareholders of the buyer).
- Type D – Divisive reorganization. There are three different types:
- Spin-off (most common. This is where the corporation distributes subsidiary stock as a property dividend. Consequently, the shareholders now own both the parent and subsidiary.
- Split-off. Some of the subsidiary stock is distributed to some of the shareholders as a redemption of their stock. Here, there are two companies with split ownership.
- Split-up. Here, the corporation distributes the subsidiary in liquidation of itself. That is, the parent corporation no longer exists.
- Single firm reorganizations
- Type E – Recapitalized by exchanging debt for equity
- Type F – Change in form, meaning the state of incorporation (moving locations)
- Type G – Bankruptcy organization, reorganizaed by chapter 11 of the bankruptcy code.
