Wassim Zhani Chapter 5 Complete Liquidations.pdf

Complete Liquidations
Solutions to Tax Research Problems
TA X RE S E A R C H PR O B L E M S
5-32 In Kimbell-Diamond Milling Co., the government successfully argued that the purchase of corporate stock
followed immediately by a liquidation should be treated as a purchase of the acquired corporation’s assets.
The basis of the assets equals the purchase price of the stock. The reclassification of a stock purchase into
an asset purchase is referred to as the Kimbell-Diamond doctrine.
5- In Snively, the Tax Court and Court of Appeals expanded the Kimbell-Diamond doctrine to cover the
purchase of stock by individuals. In Kimbell-Diamond, a corporation acquired the stock of another corporation.
5- Congress codified the Kimbell-Diamond doctrine in old § 332 and § 334(b)(2). At that time, it was
uncertain if the Kimbell-Diamond doctrine survived the Code change. In Chrome Plate, Inc., the Court of
Appeals stated that the only way to treat a stock purchase as an asset purchase was to meet the formal
conditions of § 332 and § 334(b)(2). Congress endorsed this decision when it replaced §§ 332 and 334(b)(2)
with § 338.
5- Section 338 applies only to the purchase of stock by a corporation. Because S is an individual, it can
be argued that the Kimbell-Diamond doctrine, as expanded by Snively, is still viable. Applying these rules,
S would have a basis of $600,000 for the asset (cost of the stock) and no gain or loss would be recognized
on liquidation. If S were a corporation, its basis would be limited to $200,000 under §§ 332 and 334, since
the corporation did not make the required election under § 338 to receive a step-up in basis.
5-33 In order for Data Corporation (Data) to make a valid § 338 election, a qualified stock purchase of Sales
Corporation (Sales) must occur. Section 338(d)(3) defines a qualified stock purchase as
5- any transaction or series of transactions in which stock of one corporation possessing (A) at least 80 percent
of the total combined voting power of all classes of stock entitled to vote, and (B) at least 80 percent of the
total value of all the stock … is acquired by another corporation by purchase during the 12-month acquisition
period.
5- The 12-month acquisition period, according to § 338(h)(1), is any 12-month period during which the
80 percent control test is satisfied. Data achieved 80 percent control of Sales. However, the control was not
achieved solely by purchase, but rather by purchase and redemption. Additionally, the period extended
longer than 12 months. There are three questions (issues) to be answered. First, can redemptions be used to
satisfy the requirements of a qualified stock purchase? Second, are any extensions of the 12-month
acquisition period permitted (i.e., pursuant to a plan)? Third, does Data’s intent to purchase Sales’ assets
have any impact?
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5-1

5- Issue 1—Redemption: Temp. Reg. § 1.338-4T(c)(4) states:
5- A qualified stock purchase is made on the first day on which the percentage ownership requirements of
section 338(d)(3) are satisfied by reference to T stock [Target] that is both (A) held on that day by P and
(B) purchased by P during the 12-month acquisition period ending on that day … T stock redemptions from
persons unrelated to P that occur at any time before the close of the 12-month acquisition period (whether
before or after the beginning of that period and whether before or after the purchase of any T stock by P) are
taken into account as reductions in T’s outstanding stock for purposes of determining whether T stock
purchased by P in the 12-month acquisition period satisfied section 338(d)(3).
5- The parenthetical note seems to concern redemptions occurring before or during the 12-month period,
whereas Sales’ redemption occurred after the period. Examples (4) and (5) of Temp. Reg. § 1.338-4T
specifically address a situation similar to Sales’. The basic facts are as follows: A owns all 100 shares of T’s
only class of outstanding stock. On February 1, 1984, P purchases 30 shares of T from A, and 30 more
shares from A on January 15, 1985. T redeems 25 shares on April 1, 1985. A qualified stock purchase is
not made by P on April 1, 1985. This result is obtained because the percentage ownership requirements of
§ 338(d)(3) are not satisfied on that date by reference to T stock held on that date that was purchased
during the preceding 12 months, since such stock represents 40 percent (30/75) of T’s stock.
5- Applying the above temporary regulation to Data’s acquisition of Sales, Data acquired 30/70, or
43 percent, of Sales at December 31, 2009, taking into account the November and December redemptions
plus purchases during the preceding 12 months. (Note: There is no difference if it is assumed that all are to
be redeemed on November 1, 2009.) Thus, the 80 percent control test is not achieved. However, judicial
doctrine arising under old § 334(b)(2)—which had the same statutory control test for a purchase as does
§ 338—permitted redemptions to be taken into account for the 80 percent test as long as the redemption
occurred before the liquidation date [see Madison Square Garden Corp. v. Comm., 500 F.2d 611, 74-2
USTC ¶9615, 34 AFTR2d 74-5612 (CA-2, 1974)]. Because the case conflicts with the temporary regulation,
it is uncertain if it continues to have validity. Because Data did not achieve control within 12 months, we
turn to the second issue to determine if there are any valid extensions to this period.
5- Issue 2—Beyond 12 Months: The Code and the temporary regulation do not mention any extensions of
the 12-month requirement, with the exception of an extension to prevent avoidance of the consistency rules.
However, the consistency rules are not applicable to this case. The Committee Reports for TEFRA [the
1982 legislation that enacted § 338 and repealed § 334(b)(2)] specifically state that the purchase must be
made during a 12-month period and no deviation from this rule is mentioned. The very essence of the bill
indicates that Congress sought strict adherence to the statutory rules: “The bill is also intended to replace
any nonstatutory treatment of a stock purchase as an asset purchase under the Kimbell-Diamond doctrine.”
[Tax Equity: Fiscal Responsibility Act, 1982, U.S.C.C. & A.N., 192.] Although TEFRA repealed
§ 334(b)(2), the case law existing under the old statute may be relevant for ascertaining the rigidity of the
12-month period because § 334(b)(2) had the same purchase requirements. Generally, the courts have
agreed that strict compliance with the statute is necessary. [See Yoc Heating Corp., 61 T.C. 168 (1973).] In
American Potash & Chemical Corp. [399 F.2d 194, 68-2 USTC ¶9472, 22 AFTR2d 5161 (Ct. Cls., 1968)], a
taxpayer did not fall under § 334(b)(2) because the acquisition occurred during a 14-month period.
Additionally, the use of the step transaction doctrine was denied to a taxpayer wishing to use it to satisfy
the 80 percent test [Estate of E. Brooks Glass, Jr., 55 T.C. 543 (1970); see also Granite Trust Co., 238 F.2d
670, 57-1 USTC ¶9201, 50 AFTR 763 (CA-1, 1957)]. Rev. Rul. 60-262, 1960-2 C.B. 114 states that the
formal requirements of § 334(b)(2) of the Code are significant and the element of purpose or intent is
immaterial.
5- In summary of issues 1 and 2, Data has not acquired Sales in a qualified stock purchase as defined in
§ 338(d)(3). Therefore, a valid § 338 election appears unlikely. The remaining question is the relevance of
Data’s intent. If Data intended to purchase Sales’ assets, would the substituted basis rules under the
Kimbell-Diamond doctrine apply?
5- Issue 3—Intent: Before the enactment of § 338, there were some disagreements among the courts as to
the continuing vitality of the Kimbell-Diamond (K-D) doctrine. If the transaction did not specifically satisfy
the § 334(b)(2) exception to carryover basis, then one Circuit ruled that K-D would apply in determining
the basis of the liquidated assets [see American Potash]. Other courts believed that § 334(b)(2) intended the
statute to supplant the subjective intent test of K-D. [See International State Bank, 70 T.C. 173; Broadview
Lumber, 561 F.2d 698, 77-2 USTC ¶9615, 40 AFTR2d 77-5650 (CA-7, 1977); Boise Cascade, 288 F. Supp
770, 68-2 USTC ¶9509, 22 AFTR2d 5116 (D.Ct. Idaho, 1968); Pacific Transport, 483 F.2d 209, 73-2
USTC ¶9615, 32 AFTR2d 73-5663 (CA-9, 1973); and Security Industries, 702 F.2d 1234, 83-1 USTC
¶9320, 51 AFTR2d 83-1183 (CA-5, 1983).] The enactment of § 338 eliminated any doubt regarding K-D’s
continuing usefulness. The Committee Reports provide that the bill is intended to replace any nonstatutory
treatment of a stock purchase or an asset purchase under K-D [1982 U.S.C.C. & A.N., 192]. Thus, only
5-2 Chapter 5 Complete Liquidations

those stock purchases satisfying the conditions of § 338 may be elected to be treated as asset purchases, and
intent is not relevant!
5- Data will not be able to resort to the K-D intent test upon failing to satisfy § 338. In conclusion, based
on the facts provided, it does not appear that Data will be able to make a § 338 election.
5-34 On the surface, it appears that J has found a way to liquidate Average Corporation without recognizing the
gain. Section 336(d)(1) does not apply because the property was sold rather than distributed to a related
party. Section 336(d)(2) does not apply because the property was contributed more than two years before the
adoption of the plan of liquidation. However, it should be anticipated that the IRS will challenge this result.
5- If the property that J contributed was personal-use property in his hands, the IRS will reduce the basis
of the property to its fair market value on the date of contribution pursuant to Reg. § 1.167(g)-1. If it was
business property, the IRS could argue that the corporation never really owned the property. Instead, the
corporation sold the property as an agent for J, based on the decision in Court Holding Co., 45-1 USTC
¶9215, 33 AFTR 593, 324 U.S. 331 (1945). Consequently, the loss should have appeared on J’s return
rather than on the corporation’s return. Another possibility would be for the IRS to argue that Average
had adopted an informal plan of liquidation at the time the property was contributed. Under Reg. § 1.337-
2(b), the date a plan is adopted is determined from all the facts and circumstances. A finding of an
informal plan would result in the denial of loss under § 336(d)(2).
5- The Treasury has been granted broad powers to draft regulations to prevent circumventing the repeal
of General Utilities. It should be anticipated that these regulations will contain language sufficient to bar
schemes similar to the one proposed by J. Therefore, it is likely that J’s plan will not succeed.
5-35 In the case at hand, Consulting, Inc., a cash basis personal service corporation cannot meet its obligations.
Therefore, it plans to liquidate by distributing all its assets to its sole shareholder, John Smith. One asset
that will be distributed during liquidation is a $3 million receivable from Consulting’s largest client. This
client is currently going through Chapter 11 proceedings. Due to the uncertainty of the results of these
proceedings, it is impossible to determine the fair market value of this receivable.
5- Internal Revenue Code §§ 331 and 336 apply to complete corporate liquidations. Under § 331 the
shareholder must recognize a gain or loss on distributions in complete liquidation of a corporation. These
distributions are considered to be payments for the shareholder’s stock. The amount of gain or loss to be
recognized under this type of transaction equals the difference between the fair market value of the assets
received (less any liabilities assumed) and the basis of the stock surrendered. Generally, the gain or loss will
be capital in nature since stock is usually a capital asset.
5- On the other side of the transaction, § 336 requires the liquidating corporation to recognize a gain or
loss on the distribution of property as part of a complete liquidation. The gain or loss is computed as if the
property were sold to the shareholder at its fair market value.
5- Because the accounts receivable cannot be accurately valued, problems arise for Consulting and its
shareholders when trying to calculate the gain or loss that must be recognized. According to Burnet v. Logan,
283 U.S. 404 (1931), if an asset cannot be valued with reasonable accuracy at the time of liquidation, the
calculation of gain or loss must be held open with respect to this asset until it has been sold, collected, or
otherwise reduced to cash or property. When considering this problem, Congress intended the use of open
transaction treatment to be severely limited to only “rare and unusual” cases involving contingent payments in
which the fair market value of the corporation’s obligation cannot be reasonably ascertained.
5- Several advantages result from using the open transaction rules. First, if the sale remains open, the cost
recovery method is allowed in computing the gain or loss. Using this method, payments are applied first to
recover the basis of the stock. Gain will only be recognized once total basis has been recovered [Westover v.
Smith, (1949, CA-9) 173 F2d 90, 49-1 USTC 9189]. However, loss cannot be recognized until all payments
are received.
5- A second advantage arises concerning the characterization of the gain or loss. Under the open
transaction rules all payments are deemed to be from the sale or exchange of stock. Thus, all gain or loss
will be capital in nature. If the transaction is closed, any additional gain from the collection of the
receivable would be characterized by reference to the asset and not the stock. In this case, additional gain
or loss would be ordinary since the receivable arose in the ordinary course of business.
5- Under prior law, another advantage of the open transaction rules applied to the liquidating
corporation. Under normal situations, the receipt of note payments would be taxable to the corporation as
ordinary income. The shareholder would also have income when the corporation made the liquidating
distribution. If the corporation liquidated with a contingent outstanding, the shareholder would be taxed
on the payments as receipt on the sale or exchange of stock without the corporation having recognized any
income [Shea Co. (1969) 53 T.C. 135(A)]. The important issue was that the corporation no longer existed.
If the corporation was not in existence, it could not be taxed.
Solutions to Tax Research Problems 5-3

5- Under the current tax code, this advantage may no longer exist. According to § 61, a corporation in
the process of liquidation is taxable on all income earned up to the time of liquidation even though the
income may not have been received. In addition, the assignment of future earnings to stockholders would
not be recognized for tax purposes. In this case, the income from the receivable was earned by Consulting
before it was liquidated. However, due to the method of accounting used by Consulting, the income had
not been recognized at the corporate level. Therefore, under this rule the corporation would be taxed on
the receivable when the payments are received by the shareholder.
5- Based on these rulings, it would appear that is liquidation qualifies for the “open transaction” rules. If
the fair market value of Consulting’s other assets exceed the shareholder’s stock basis, they would report a
capital gain currently to the extent of this difference. As collections are made on the receivable, the
shareholders would report additional capital gain for the full amount received. On the other hand, if the
fair market value of Consulting’s other assets is less than the shareholder’s basis, they would not report
either gain or loss currently. Gain would only be recognized only after total basis has been recovered. Loss
would only be recognized if total basis was not recovered after all payments were received. In either case,
the corporation would also have a gain equalling the difference between the fair market value of the other
assets and the corporation’s basis in these assets. The corporation also would report ordinary income to the
extent of any additional payments made on the receivable.

Test Bank
True or False
1. It is necessary for a corporation to dissolve before a liquidation can be completed.
2. Shareholders generally treat the amounts received in a liquidation as amounts received in full payment
of their stock.
3. A shareholder reports a total gain or loss on a liquidation even if the stock was acquired at different
times.
4. Shareholders can accelerate the recognition of loss on a complete liquidation by receiving payments in
two or more years.
5. Gains and losses on liquidation distributions received all in one year may be deferred over two or
more years using the cost recovery method.
6. When a shareholder receives an installment note attributable to a sale of property by a liquidating
corporation, receipt of the note is always treated as full payment for the stock for Federal income tax
purposes.
7. As a general rule, shareholders calculate gains and losses on liquidations based on the full fair market
value of any installment notes received.
8. A shareholder can defer the recognition of gain on liquidation when an installment note is received, if
the note arose from the sale of all the corporation’s assets within the 12-month period starting with the
adoption of the plan of liquidation.
9. After the repeal of all rules based on the General Utilities doctrine, revised § 336 now provides that, as
a general rule, a corporation does not recognize any gains or losses when distributing its assets to its
shareholders in complete liquidation.
10. The treatment of distributions in liquidations differs from that in nonliquidating distributions in that
the corporation is always allowed to recognize loss on a liquidating distribution.
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5-5

11. A parent corporation generally recognizes no gain or loss on property it receives upon the liquidation
of a subsidiary corporation.
12. In the liquidation of a subsidiary under § 332, gains and losses will be recognized on the distribution of
property to minority shareholders.
13. When a subsidiary is liquidated by its parent corporation, the basis of the assets transferred from the
subsidiary to the parent is determined by the amount of the parent’s investment in the subsidiary’s stock.
14. Even though the parent corporation in a § 332 liquidation uses the carryover basis of the subsidiary as
its basis in the assets received, the depreciation recapture rules apply to the subsidiary.
15. Section 338 eliminated the Kimbell-Diamond doctrine.
16. Section 338 permits a parent corporation to elect to treat the purchase of stock of a subsidiary as a
purchase of assets “to obtain the same basis that it would have obtained had it purchased the assets
directly” (fair market value). The subsidiary must liquidate when the parent elects § 338.
17. Assuming a proper election has been made under § 338, a subsidiary corporation determines its basis
in assets as equal to the price that the parent corporation paid for the subsidiary’s stock, adjusted by
liabilities of the subsidiary and its ownership percentage.
18. In most situations, a target subsidiary has some assets that have appreciated in value (i.e., fair market
value exceeds the asset’s basis), and other assets where the value is less than the asset’s basis. In such
case, the acquiring corporation, desiring the highest basis possible for the assets, might first purchase
the appreciated property, then purchase the subsidiary’s stock, and then liquidate the subsidiary under
§ 332. By so doing, the acquiring corporation might violate the Code’s “consistency” provision.
19. The purchaser of a corporation with an NOL carryover should consider making a § 338 election.
20. Generally, by considering a sale of stock, a corporation avoids having the value of a business
diminished directly or indirectly by the corporate level tax.
Multiple Choice
21. J purchased 100 shares of C common stock in 2007 for $1,000. J purchased another 100 shares in 2012
for $10,000. In the current year, C adopts a plan of liquidation and distributes $8,000 to J as the first
installment ($4,000 for each block). J’s recognized gain or loss on the distribution is
a. $3,000 loss
b. $0 gain or loss
c. $3,000 gain
d. $8,000 gain
22. K purchased all 100 shares of N Corporation in 2008 for $50,000. N Corporation adopts a plan of
liquidation on January 1, 2012. On May 1, 2012, N sells its only asset, land, for $10,000 cash and an
installment note with a face amount and fair market value of $90,000. On January 8, 2013, N
distributes the cash and note to K. On her 2012 tax return, K will report the following as gain or loss
from the liquidation. (Assume no collections on the installment note during 2012.)
a. $0
b. $5,000
c. $50,000
d. $100,000

installment note with a face amount and fair market value of $90,000. On December 1, 2012, N
distributes the cash and note to K. On her 2012 tax return, K will report which of the following as
gain from the liquidation? (Assume no collections on the installment note during 2012.)
a. $0
b. $5,000
c. $50,000
d. $100,000
distributes the cash and note to K. In 2013, K receives $9,000 from the installment note. How much
gain must K report in 2013?
a. $0
b. $4,500
c. $9,000
d. None of the above
distributes the cash and note to K. N’s basis in the land is $36,000. On its final return, N will report a
gain from the note of
a. $0
b. $5,400
c. $27,000
d. $54,000
26. On January 15, 2012, the Board of Directors of K Corporation voted to adopt a plan of liquidation as
of February 1, 2012. On January 25, 2012, they sell land and realize a $400,000 loss. On February 15,
2012, they sell a building acquired in 2003 and depreciated under ACRS at a $200,000 gain (total
depreciation recapture potential of $380,000). K distributes all of its assets to its shareholders on
December 31, 2012. On K’s final tax return, it will report
a. $400,000 loss on sale of land only
b. No gain or loss on sale of land and building
c. $400,000 loss on sale of land and $200,000 ordinary income on sale of building
d. $200,000 ordinary income on sale of building only
27. R, an individual, purchased all the stock of T Corporation on January 1, 2003 for $20,000. On January 1,
2012, T adopts a plan of liquidation. On January 20, 2012, T sells land with a basis of $60,000 for $45,000.
On January 31, 2012, T distributes the $45,000 cash plus its only other asset, FIFO inventory with a basis
of $40,000 and a fair market value of $48,000, to R. Which of the following statements is true?
a. T recognizes a loss of $15,000; R recognizes a gain of $73,000 and takes inventory with a basis of
$48,000.
b. Neither T nor R recognize gain.
c. T recognizes neither gain nor loss; R recognizes a $73,000 gain and has a basis for the inventory
of $48,000.
d. T recognizes a $15,000 loss on the sale and an $8,000 gain on the distribution; R recognizes a gain
of $73,000 and has inventory with a basis of $48,000.
e. T recognizes a $15,000 loss on the sale and an $8,000 gain on the distribution; R recognizes
neither gain nor loss and has inventory with a basis of $40,000.
28. Z Corporation, in complete liquidation, distributes its only asset, land, to its sole shareholder. The
land has a basis of $40,000 and a fair market value of $55,000. The shareholder assumed Z’s liability
of $60,000. Z Corporation will report gain on the distribution of
a. $0
b. $15,000
c. $20,000
d. $60,000
Test Bank 5-7

29. L Corporation’s only assets are land and building. Their combined original cost is $1 million, basis is
$600,000, and current fair market value is $1.2 million. L elected the straight-line method of
depreciation. L distributes the land and building to its sole shareholder in complete liquidation. The
amount of income that L must report is
a. $0
b. $80,000
c. $400,000
d. $600,000
30. X is the sole shareholder of Z Shipping Corporation. In anticipation of the corporation’s liquidation,
X in 2008 contributed an ancient wharf to the corporation with a built-in loss of $1 million (value $2
million, basis $3 million). In 2012, Z distributed the wharf along with land purchased and held for
business purposes by the corporation worth $900,000 (basis $200,000). What is the amount of gain/
loss recognized by Z?
a. $1 million loss, $700,000 gain
b. $700,000 gain
c. $0
d. $1 million loss
31. The treatment of distributions in liquidation differs from that in nonliquidating distributions in that
the corporation is normally allowed to recognize loss on a liquidating distribution. To prevent abuse
of this privilege to circumvent the gain recognition rule, restrictions prohibit the liquidating
corporation from recognizing losses on distributions to related parties if:
a. The distribution is non-pro rata (i.e., each shareholder did not receive his or her pro rata share of
each type of property).
b. The property was acquired during the first two years of a corporation’s existence.
c. There is a “clear and substantial relationship” between the contributed property and the
corporation’s current or anticipated business.
d. All of the above
32. The parent T Corporation owned 80 percent of Company J’s stock as of February 2, 2012; on June 2,
2012, a liquidating distribution of all of Company J’s property was made to T Corporation in
complete redemption of the subsidiary’s stock in accordance with a formal plan. Which element of
these proceedings was not required by provisions of § 332 regarding liquidation of subsidiaries?
a. A formal plan
b. 80 percent ownership of the subsidiary’s stock
c. 100 percent property distribution
d. Distribution of all assets within one taxable year of the subsidiary or a formal plan
33. Z Corporation purchases 90 percent of B Corporation’s outstanding common stock for $1 million on
January 1, 2003. On June 15, 2012, B adopts a plan of liquidation and distributes assets with a fair
market value of $1.2 million and a basis of $900,000 to Z. B distributes assets with a fair market value
of $133,333 and a basis of $90,000 to the minority shareholders. Which of the following is true?
a. Z Corporation recognizes neither gain nor loss and has a basis in the assets received of $900,000.
b. Z Corporation recognizes neither gain nor loss and has a basis in the assets received of $1 million.
c. Z Corporation recognizes $20,000 gain and has a basis in the assets received of $1 million.
d. Z Corporation recognizes a gain of $34,333 and has a basis in the assets received of $1 million.
34. X Corporation is owned by Y Corporation and T, an individual. Y owns 90 percent of X’s stock, and
T owns the other 10 percent. X adopts a plan of liquidation and distributes land with a basis of
$700,000 and a fair market value of $900,000 to Y, and marketable securities with a basis of $40,000
and a fair market value of $100,000 to T. X must report gain or loss of
a. $0
b. $60,000
c. $186,000
d. $260,000

35. R Corporation, a men’s clothing retailer, purchased all of the stock of L Corporation, a women’s
clothing retailer, for $200,000 as part of a plan to diversify. But L Corporation became insolvent, with
liabilities of $500,000 and assets of $350,000. R decided to liquidate L. R’s tax loss related to the
liquidation is
a. $350,000
b. $200,000
c. $150,000
d. $0
36. A Corporation owns 90 percent of the outstanding stock of B Corporation; the remaining 10 percent
is owned by unrelated parties. In a liquidation pursuant to § 332, B distributed and transferred
property to A with a fair market value of $80,000 (basis $30,000). In addition, B distributed and
transferred property to the minority shareholders worth $11,000 (basis $9,000). How much gain does
B realize?
a. $50,000
b. $52,000
c. $2,000
d. $0
37. Q Corporation is a wholly owned subsidiary of P Corporation. P has an account receivable from Q in
the amount of $50,000. As a part of a complete liquidation, Q transfers property (fair market value of
$50,000 and basis of $30,000) to P in settlement of the debt. What is the amount of gain that Q should
recognize?
a. $20,000
b. $30,000
c. $0
d. $50,000
38. Q Corporation had assets with a basis of $800,000 and no liabilities. P Corporation bought all the
stock of Q Corporation for $1 million. Three years later, when Q Corporation’s assets had shrunk to a
basis of $600,000, P Corporation liquidated Q Corporation in a tax-free liquidation under § 332. What
is P Corporation’s basis in the assets received from Q Corporation? (Assume that P Corporation’s
basis in its assets not received from Q Corporation at the time of liquidation of Q was $750,000.)
a. $400,000
b. $800,000
c. $1 million
d. $600,000
39. What are the provisions of § 338 for avoiding the abuses under Kimbell-Diamond ?
a. Stock purchases must be treated as a purchase of assets.
b. A subsidiary must be acknowledged to have been acquired with the intent to obtain its assets.
c. It is required that the subsidiary actually be liquidated.
d. All of the above
e. None of the above
40. Y Corporation purchases S stock as follows:
November 15, 2010 10 percent
February 12, 2011 5 percent
November 12, 2011 60 percent
December 28, 2011 10 percent
The last date that Y can purchase another 10 percent of S stock and still qualify for the § 338 election is
a. December 31, 2011
b. January 14, 2012
c. February 11, 2012
d. November 11, 2012
e. not relevant; Y will never qualify to make the § 338 election.
Test Bank 5-9

41. D Corporation purchased all of the stock of E Corporation for $1 million. E’s only asset is land with a
basis of $200,000. E had no liabilities. D elects § 338. D also liquidates E. E is deemed to have sold its
land for fair market value, and E must recognize a gain of $800,000. The tax liability resulting from
the deemed sale is $272,000 ($800,000 34%). What is D’s basis in the land?
a. $728,000
b. $1,272,000
c. $1 million
d. $200,000
42. X Corporation purchased 90 percent of Y Corporation on February 3 of the current year for $1.2
million and made a § 338 election. The fair market value of Y Corporation’s assets is $1.3 million, and
its basis is $900,000. Select the correct statement.
a. Y Corporation recognizes neither gain nor loss and increases the basis of its assets to $1.2 million.
b. Y Corporation recognizes $300,000 gain and increases the basis of its assets to $1,333,333.
c. Y Corporation recognizes $400,000 gain and increases the basis of its assets to $1,333,333.
43. The term grossed-up basis
a. Refers to adjustment of the deemed price of a subsidiary corporation for a minority interest when
a parent corporation owns less than 100 percent of the subsidiary and elects § 338.
b. Is obtained by the following formula:
% of subsidiary’s
Grossed-up Parent corporation’s stock held by parent
basis ¼ basis in subsidiary’s on the acquisition date
stock on the acquisition date 100%
c. Requires that the parent corporation purchase at least 90 percent of the subsidiary’s stock (except
nonvoting, nonparticipating, preferred stock).
d. Is described by all of the above.
44. Assets are grouped into five classes under provisions of § 338. The method of establishing the value of
Class V, or intangible, assets in the nature of goodwill or going concern value is
a. To determine the fair market value by appraisal on election date
b. To assign 20 percent of fair market value to intangible assets according to the 20 percent allocation rule
c. To assign what remains, after fair market value allocations to the four other classes, to the
goodwill or going concern value
d. All of the above
e. None of the above
45. F Corporation purchases from an unrelated person 100 percent of the stock of G Corporation on
April 20 of the current year. Assume the purchase price, adjusted for all relevant items, is $200,000.
G’s assets at acquisition date are
Class Basis Fair Market Value
I Cash $ 20,000 $ 20,000
III Accounts receivable 40,000 40,000
IV Inventory 50,000 110,000
Total $110,000 $170,000
Under provisions of § 338, the purchase price is first allocated to cash in the amount of $20,000. This
leaves $180,000 to be allocated. As there are no Class II assets, the allocation is to Class III and IV.
How should the remainder be allocated?
a. Allocate $180,000 to the receivables and inventory; income from the sale of the inventory would
be reduced. This will allow a loss to be taken when the receivables are collected.
b. Allocate $150,000 to the receivables and inventory. Because the remaining purchase price exceeds
the fair market value of the Class III and IV assets, the basis of the assets in this class is limited to
their fair market value.
c. Allocate $90,000 to the receivables and inventory. The basis of the parent corporation is that of
the subsidiary corporation, according to the carryover principle under § 338.

46. When a new corporation is created from the old subsidiary under provisions of § 338, the new
corporation may
a. Adopt any tax year that suits its purposes, limited only by the consolidated return rules
b. Disregard anti-churning rules and use ACRS depreciation for all of the purchased property
c. Not have available any net operating loss carryovers of the old subsidiary
d. Do all of the above
47. H Corporation purchased 55 percent of J Corporation’s stock on April 5, 2011 and the remaining 45
percent on July 28, 2011. The time known as the consistency period under provisions of § 338 runs
from April 5, 2010 through July 28, 2012. If H acquires any assets of J during this period, except in
the ordinary course of business,
a. Their value is determined by carryover of the subsidiary’s basis to the parent corporation.
b. Under the consistency rule, provisions of § 332 must govern the determination of their value.
c. It is deemed to have made a § 338 election to treat the stock purchase as an acquisition of assets,
thus precluding a carryover basis.
d. None of the above are true.
48. From the following list identify the one item that does not describe one of the difficulties commonly
presented by asset sales as compared to stock sales.
a. Transfer of titles
b. Notification of creditors in conformance with the applicable bulk sales laws
c. Nonassignable rights such as a license, lease, trademark, or other favorable contractual arrangement
d. Unwillingness of minority shareholders to sell even though the buyer does not want to share the
business with outsiders
49. From the buyer’s perspective, a sale of stock may be preferable to a sale of assets because
a. The purchaser obtains not only all of the assets but all of the liabilities.
b. When product liability or adjustments in prior taxes are unknown, the seller may be required to
indemnify the buyer for any undisclosed liabilities.
c. A sale of stock results in only a single tax.
d. Both a. and c., but not b.
50. K Corporation is 100 percent owned by Seller, who has a basis in her stock of $10,000. K Corporation’s
sole asset is a waterbed factory worth $100,000 (basis $30,000). If Buyer purchases all the stock of
K Corporation for $100,000, Buyer will own a corporation that holds a waterbed factory with a basis in
the factory of $30,000, much less than the cost to Buyer. If Buyer is a corporation, a § 338 election could
be made to obtain a step-up in basis to $100,000 for the factory. The result would be
a. A deemed sale of the factory and a tax on a gain of $70,000 ($100,000 $30,000 basis)
b. A tax on the gain of $90,000 ($100,000 $10,000 basis)
c. No tax, as basis would be carried over from the subsidiary corporation
51. K Corporation is 100 percent owned by Seller, who has a basis in her stock of $10,000. K
Corporation’s sole asset is a waterbed factory worth $100,000 (basis $30,000). If Buyer purchases all
the stock of K Corporation for $100,000, Buyer will hold the waterbed factory with a basis in the
factory of $30,000, much less than the cost to Buyer. If Buyer is not a corporation, Buyer would
a. Recognize a gain of $70,000 on the distribution of the property in liquidation
b. Have no gain on the liquidation because the basis in the stock, $100,000, is equivalent to the
value of the assets received
c. Pay a single tax on the gain of $90,000 ($100,000 $10,000 basis)
d. Do none of the above
52. T Corporation purchased all of the stock of V Corporation last year for $1.2 million. V has a basis in
its assets of $1.7 million. T Corporation does not elect § 338. A year later, W Corporation indicates
that it would like to purchase the business of V for $1.4 million. Good tax planning dictates that T
Corporation should
a. Liquidate V Corporation under § 332 and then sell the assets
b. Sell the V Corporation stock
c. Sell the assets without liquidating V Corporation
d. Do none of the above
Test Bank 5-11

53. When the general liquidation provisions of § 331 apply, consideration should be given to the
possibility of minimizing tax obligations. Available planning options include
a. Placing gifts in trusts
b. Arranging a series of liquidating distributions that spans several years
c. Selling stock for transfer to a trust with a reversionary interest
d. All of the above
54. In assessing whether to use a § 338 election, considerations include
a. Tax benefits resulting from the step-up in basis enabled by a § 338 election (e.g., increased
depreciation) are deferred.
b. When part of the basis is assigned to goodwill, no tax benefit is obtained until the acquired
business is sold.
c. Future tax savings being discounted to determine their present value
d. All of the above

Solutions to Test Bank
True or False
1. False. A corporation is not required to dissolve to complete a liquidation. In fact, the retention of a
nominal amount of assets to preserve the corporation’s legal existence is permitted. [See pp. 5-2 and 5-3,
and Reg. § 1.332-2(c).]
2. True. Shareholders are treated as having sold their stock for amounts received in a liquidation. (See p. 5-3
and § 331.)
3. False. If stock was purchased at different times and for different amounts, the gain or loss is computed on
each separate lot. [See Example 2, p. 5-4 and Reg. § 1.331-1(e).]
4. False. Although the shareholder uses the cost recovery method to recognize gain or loss on a complete
liquidation, loss may not be recognized until the final payment is received. (See Example 4 and pp. 5-4
and 5-5.)
5. False. If all payments are received in one year, the gain or loss must be recognized that year. (See footnote
8 and p. 5-5.)
6. False. A special tax treatment is available, provided that certain liquidation requirements are met, which
allows cash collections on the note (rather than the receipt of the note itself) to be treated as payment for
the stock for income tax purposes. [See pp. 5-5 and 5-6 and § 453(h)(1)(A).]
7. True. Unless the note qualifies for special treatment under § 453(h)(1)(A), the full fair market value is to
be used to calculate gain. (See p. 5-6.)
8. False. Installment notes from the sale of inventory do not qualify unless the sale is a bulk sale. (See p. 5-5.)
9. False. Under revised § 336, the corporation will recognize gains and losses on the distribution. This
treatment is in contrast to the General Utilities doctrine. (See pp. 5-7 and 5-8.)
10. False. The liquidating corporation is prohibited from recognizing losses on distributions to related parties
if the distribution is either non-pro rata or if the distributed property was acquired by the corporation
during the five-year period prior to the distribution. [See pp. 5-8 and 5-9 and § 336(d).]
5
5-13

11. True. The point of § 332 was to permit corporations to simplify complex corporate structures tax-free. In
such case, any gain or loss not recognized is deferred through the basis provisions. (See pp. 5-11 and 5-12
and § 332.)
12. False. Gain—but not loss—will be recognized according to § 336(d)(3). (See Example 18 and p. 5-14.)
13. False. The parent’s basis is determined solely by the subsidiary’s basis. [See pp. 5-14 and 5-15 and
§ 334(b)(1).]
14. False. Because the parent uses the carryover basis, the recapture rules do not apply. (See p. 5-15.)
15. True. Although there was some question under old § 334(b)(2), the Committee reports on the 1982 Tax
Act clearly state that § 338 replaces the Kimbell-Diamond doctrine. (See p. 5-15.)
16. False. A § 338 election does allow the parent to treat the purchase of stock as the purchase of assets.
However, it is not necessary to liquidate the subsidiary. (See pp. 5-16 and 5-17.)
17. True. The basis of the assets is generally the price paid by the acquiring corporation for the subsidiary’s
stock, as adjusted for certain items, such as tax liability. (See pp. 5-17 through 5-19 and § 338.)
18. True. An acquiring corporation is deemed to have made an election under § 338 to treat a stock purchase
as an acquisition of assets—thus precluding a carryover basis—if it purchased any of the target
subsidiary’s assets during the consistency period—one year before the date of the first acquisition that
comes within § 338 and ending one year after the acquisition date. (See p. 5-20 and § 338.)
19. True. Any gain recognized will offset the NOL and cause no additional current taxation. (See pp. 5-18
through 5-21.)
20. False. If the corporate level tax is not paid directly in a sale of assets, the savvy buyer will insist upon a
reduced sales price. (See pp. 5-22 and 5-24.)
Multiple Choice
21. c. $3,000 gain. The gain or loss is calculated separately for each block of stock, using the cost recovery
method
2007 purchase: Received $ 4,000
Basis 1,000
Gain $ 3,000
2011 purchase: Basis $10,000
Received 4,000
Unrecovered basis $ 6,000
(See Example 2 and pp. 5-3 and 5-4.)
22. c. Since the distribution occurred more than 12 months after the adoption of the plan of liquidation, the
note is considered received by the shareholder. (See Example 6, pp. 5-5 and 5-6.)
23. b. The distribution now qualifies for the special rule under § 453(h)(1)(A). Thus, $5,000 of the stock’s
basis is allocated to the cash, generating a $5,000 gain. (See pp. 5-5 and 5-6.)
24. b. $45,000 of the stock’s basis is allocated to the note. The profit ratio is 50 percent ($45,000 profit/
$90,000 face). Thus, 50 percent of the $9,000, or $4,500, is gain. (See Example 7, p. 5-6.)
25. d. Even if the sale is accounted for under the installment method, the distribution of the note will be
treated as a sale resulting in recognition of the full amount of gain. (See p. 5-7.)

26. c. The Tax Reform Act of 1986 repealed the General Utilities doctrine and old § 337. Therefore, all gains
and losses will be recognized. (See pp. 5-7 and 5-8.)
27. d. T will recognize the loss on the sale and the gain on the deemed sale under § 336. R will recognize gain
under § 331. (See pp. 5-3 and 5-7.)
28. c. When a shareholder assumes a liability, the fair market value of the property is considered to be no less
than the amount of the liability. (See Example 10 and p. 5-8.)
29. d. Under § 336, the corporation is deemed to have sold its assets for their fair market value. (See Example 9,
p. 5-7.)
30. b. Absent a special rule, Z would recognize a loss of $1 million, which would offset the gain it must recognize
on the land of $700,000 ($900,000 $200,000). Under a special rule for distributions to related parties,
however, no loss is recognized, because the distribution is to a related party, X, and was acquired by the
corporation within five years prior to the liquidation. [See pp. 5-8 and 5-9 and § 336(d)(1).]
31. a. Answers b. and c. are exceptions to the basis-reduction rule; persons who form a new corporation by
transferring assets to it during the first two years of a corporation’s existence are not penalized if they
are later forced to liquidate the venture, nor are they penalized if contributed properties bear a relation
to the corporation’s business. [See pp. 5-8 through 5-10 and § 336(d).]
32. a. Section 332 requires that b. and c. be satisfied. However, if a distribution is carried out within one
taxable year of the subsidiary, no formal plan is required. Otherwise, a formal plan of liquidation must
exist and the distributions must be made within three years of the close of the year in which the first
distribution is made. (See pp. 5-11 and 5-12 and § 332.)
33. a. Under § 332, a parent does not recognize gain or loss on the liquidation of a subsidiary. The basis of
the assets carry over to the parent. The cost of the stock is ignored. (See pp. 5-11 through 5-16.)
34. b. X will recognize gain only on the distribution to T, the minority shareholder. The gain on the
distribution to Y is not recognized by § 337. (See Example 18 and pp. 5-13 and 5-14)
35. b. The liquidation rules do not apply because L is insolvent. R Corporation may deduct $200,000 as an
ordinary loss because L is an affiliated corporation. [See Example 16, p. 5-12, and § 165(g).]
36. c. B recognizes no gain on the distribution to A because § 332 exempts a subsidiary from gain or loss
recognition on distributions of property to its parent. However, B must recognize a gain of $2,000
($11,000 $9,000) on the distribution to the minority shareholders. (See Example 17, p. 5-13 and
§§ 331, 332, 334, and 337.)
37. c. Section 337(b) provides nonrecognition for transfers of appreciated property to a parent in payment of
a debt as part of a subsidiary liquidation. (See Example 19, p. 5-14.)
38. d. When a subsidiary is liquidated, the basis of assets transferred is the same for the parent corporation as
it had been for the subsidiary, on a carryover basis. The amount of the parent’s investment in the
subsidiary’s stock is ignored; the parent’s basis is determined solely by the subsidiary’s basis, or
$600,000 in this case. [See Example 20, p. 5-14 and § 334(b)(1).]
39. e. If a parent corporation purchases the stock of a subsidiary, it may elect to treat the stock purchase as a
purchase of assets. This election enables the parent to obtain the same basis that it would have obtained
had it purchased the assets directly. However, there is no requirement that the subsidiary be acquired
with the intent to obtain its assets, or that it actually be liquidated. (See pp. 5-16 and 5-17 and § 338.)
40. d. To qualify for § 338, the parent must purchase at least 80 percent of the stock within a 12-month
period. The 12-month period ending November 11, 2012 will include the November 2011, December
2011, and November 11, 2012 purchases for a total of 80 percent. (See Example 23 and pp. 5-16
and 5-17.)
Solutions to Test Bank 5-15

41. b. After the hypothetical sale and repurchase, D’s basis in the land is $1,272,000, its $1 million purchase
price of the stock, increased by the $272,000 liability from the deemed sale. (See Example 25, p. 5-18
and § 338.)
42. d. The correct amount of gain recognized is $400,000. If it were not for the tax liability, S would increase
its basis in its assets to $1,333,333 [$1.2 million price of stock ? (100%/90% ownership)]. Since the tax
liability increases the deemed price of the stock, the basis of the assets is greater than $1,333,333 by the
amount of tax liability S owes. (See Example 25, pp. 5-17 and 5-18.)
43. a. The adjustment for a minority interest results in a deemed purchase price called the grossed-up basis,
obtained by multiplying the actual purchase price of the stock by a ratio, where the numerator is
100 percent and the denominator equals the percentage of the subsidiary stock owned by the parent.
And, just as in any § 338 liquidation, the parent corporation is required to own at least 80 percent of
the subsidiary’s stock. (See Example 26, pp. 5-17 and 5-18 and § 338.)
44. c. The purchase price is allocated to the first four classes in turn; the amount allocated cannot exceed the
fair market value of any asset. Any purchase price that remains after allocations to the first four classes
is allotted to Class V, in what is known as the residual value approach. [See p. 5-19, § 338, and Temp.
Reg. § 1.338(b)-2T.]
45. b. Under § 338, the basis of the assets in this class is their fair market value, a total of $150,000. The
remainder, under the residual value approach, will be allocated to Class VII assets. [See Example 27,
p. 5-19, § 338, and Temp. Reg. § 1.338(b)-2T.]
46. d. Election of § 338 treats a new corporation created from an old subsidiary as a new corporation in every
respect. (See p. 5-20.)
47. c. To prohibit the acquiring corporation from effectively selecting the basis that is most desirable, the
Code contains the “consistency” provision. This provision precludes a carryover basis if any of the
target subsidiary’s assets are purchased during the consistency period. (See p. 5-20 and § 338.)
48. d. Generally, minority shareholders would be unable to block the sales of assets. (See pp. 5-22 through
5-24.)
49. b. It is in the seller’s interest that the purchaser assume all liabilities, and that only a single tax result on
the sale of the stock at what historically have been favorable capital gains rates. In contrast, a
provision in the contract to indemnify the buyer from undisclosed liabilities (e.g., product liability or
adjustments in prior taxes) is clearly favorable to the buyer. (See pp. 5-22 through 5-24.)
50. a. When electing § 338, there is no carryover of basis of the assets. The deemed sale is a taxable event that
directly precedes the step-up in basis. (See pp. 5-17 and 5-18.)
51. b. For the noncorporate purchaser, the basis in the stock is equivalent to the value of the assets received.
However, Buyer incurs a tax in order to obtain a cost basis in the assets, since he is ultimately
responsible for the tax on the liquidated corporation. (See p. 5-24.)
52. a. By liquidating under § 332, T can sell the assets and recognize a loss of $300,000, whereas a sale of
stock would produce a gain of $200,000. (See p. 5-24.)
53. b. A series of liquidating distributions over several years causes gain to be recognized in smaller
increments. This reduces the marginal tax rate that otherwise would apply if the shareholder received
the distribution in lump sum, or all in one year. Gifts in trusts, or where the donor retains a
reversionary interest in the trust, must be avoided. The sale of stock or property recently transferred to
a trust is normally attributed to the donor, under § 644. (See pp. 5-22 through 5-24.)
54. d. Tax benefits from the step-up in basis from a § 338 election must be carefully evaluated against their
cost. (See p. 5-24.)

Comprehensive Problems
FA C T S F O R CO M P R E H E N S I V E PR O B L E M S
The balance sheet of X Corporation shows the following:
Basis FMV
Cash $10,000 $10,000
Equipment $100,000
Less: Depreciation (60,000) 40,000 50,000
Land 1 100,000 150,000
Land 2 150,000 125,000
Total $300,000 $335,000
All of the stock is owned by A. Her basis is $200,000.
CO M P R E H E N S I V E PR O B L E M S
1. Calculate the gain or loss to X Corporation if X Corporation liquidates and distributes all of its assets to A.
2. Calculate the gain or loss to A on the liquidation in Question 1.
3. What would the answers to Questions 1 and 2 be if Land 2 were contributed by A shortly before, and in
anticipation of, the liquidation?
4. Calculate the recognized gain or loss to X Corporation if, after adopting a plan of liquidation, it sells all of
its assets for their fair market values and distributes the proceeds.
5. Calculate the gain to A following the transaction in Question 4.
6. What would your answer to Question 5 be if the proceeds from the sale consisted of $50,000 cash for the
equipment and a $275,000 installment note for the two parcels of land?
7. Y Corporation purchases the stock from A for $335,000. Y immediately liquidates X Corporation. How
much gain or loss is recognized by X and what are the bases of the assets to Y?
8. Same facts as Question 7 except Y Corporation made a § 338 election. Assume a corporate tax rate of
30 percent. How much gain or loss is recognized and what are the bases of the assets?
5
5-17

Solutions to Comprehensive Problems
1. Under $ 336, X is treated as if it sold its assets for their fair market values.
FMV $335,000
Basis 300,000
Gain $ 35,000
2. Under $ 331, A is treated as having sold her stock for the value of the property received.
FMV $335,000
Basis 200,000
Gain $135,000
3. Under $ 336(d)(1), no loss is recognized on property distributed to a related party that was contributed in
order to recognize a loss in a liquidation. Therefore, only the cash, equipment, and Land 1 are considered in
computing the gain to X.
FMV $210,000
Basis 150,000
Gain $ 60,000
The gain to A is exactly the same as it is in Question 2.
4. X would sell the equipment, Land 1, and Land 2, then report gain as follows:
Sale price $325,000
Basis 290,000
Gain $ 35,000
5. The distribution of cash would not produce any additional gain.
Cash distributed $335,000
Basis of stock 200,000
Gain $135,000
6. In this case, the basis of the stock is allocated between the cash and note.
To cash $200,000
$60; 000
$335; 000
¼ $35; 820
To note $200,000
$275; 000
$335; 000
¼ $164; 180
Cash received $60,000
Basis allocated 35,820
Gain $24,180
The remaining gain will be recognized when the note is collected.

7. Under $ 332, no gain or loss is recognized. The bases of the assets carry over from X Corporation to
Y Corporation.
8. Under $ 338, Y Corporation is treated as having sold the assets for their fair market values. X Corporation
will recognize a gain of $35,000. This will generate a tax liability of $10,500 ($35,000 30%). The cost of
stock is its actual cost of $335,000 plus the $10,500 of tax liability, or a total of $345,500. Under the residual
method, the cost of stock will be allocated as follows:
Cash $ 10,000
Equipment 50,000
Land 1 150,000
Land 2 125,000
Goodwill 10,500
Total $345,500
The revised asset bases carryover to Y Corporation. The liquidation is covered by $ 332. No gain or loss is
recognized.
Solutions to Comprehensive Problems 5-19

Wassim Zhani Chapter 5 Complete Liquidations.pdf

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