Revenue Ruling 71-35 and Corporate Liquidations

Revenue Procedure 99-1 provides specific guidance for corporations undergoing a complete liquidation. It addresses a situation where a company must retain certain assets to finalize the transfer of other assets that are difficult to assign. This guidance establishes a “safe harbor,” allowing the process to still qualify as a complete liquidation for tax purposes, provided specific conditions are met. This guidance is focused on instances where the retention is solely for preserving the corporation’s legal existence to complete a pending asset transfer and is not a tool for continuing business operations.

Conditions for Applying the Ruling

To fall under the protection of this safe harbor, a corporation must satisfy requirements centered on the nature and purpose of the retained assets. The first condition is that the assets kept by the corporation must be nominal in value. This means the corporation can only hold a minimal amount of cash or other assets necessary to meet administrative needs directly related to its legal existence. For example, a small cash reserve to pay annual state franchise taxes would be permissible.

The amount should not be sufficient to engage in any former or new business activities. The focus is on maintaining the bare minimum required to remain a legal entity on paper. Any amount beyond what is strictly necessary for this purpose could disqualify the corporation from the safe harbor’s protections.

The second condition is the “sole purpose” test, which dictates why the assets are being retained. The corporation must demonstrate that the only reason for keeping these nominal assets is to preserve its name or legal status to facilitate the transfer of a specific asset. This asset must be one that could not be legally or practically transferred to shareholders before or during the primary liquidation distributions.

If the retention of assets serves any other purpose, the guidance does not apply. For instance, using the retained funds to settle old business debts or manage ongoing litigation not directly tied to a specific non-transferable asset would violate the sole purpose test.

Qualifying Asset Types

Intellectual property, such as federally registered trademarks, trade names, and patents, often falls into this category. The legal ownership of these assets is tied directly to the corporate entity, and transferring them can involve lengthy administrative processes with government agencies. Retaining the corporate charter allows for a clean and legally sound assignment of these rights to the shareholders or a designated recipient.

Another common qualifying asset is a pending or anticipated federal or state tax refund. The claim for the refund is in the corporation’s name, and the government will issue the payment only to that legal entity. Since the exact amount and timing of the refund are often unknown at the time of liquidation, the corporation may need to remain in existence to receive the funds and then distribute them to the shareholders.

Legal claims and judgments that are non-assignable by law also represent an asset type covered by this guidance. In some legal proceedings, the right to a potential settlement or judgment is legally bound to the plaintiff corporation and cannot be signed over to its shareholders. Once a settlement is reached or a judgment is paid, the corporation can then distribute the proceeds and complete its dissolution.

Tax Treatment of the Liquidation

When a corporation meets the conditions of this safe harbor, the distributions made to shareholders are treated as payments in a complete liquidation for tax purposes. This treatment is governed by Internal Revenue Code Section 331. Under this section, shareholders must treat the distributions as if they sold their stock back to the corporation, recognizing a capital gain or loss on the transaction.

The gain or loss is calculated by taking the fair market value of all property received from the corporation and subtracting the adjusted basis of the shareholder’s stock. If the value of the distribution exceeds the stock basis, the shareholder has a capital gain. The character of the gain or loss, whether short-term or long-term, depends on how long the shareholder held the stock.

For the liquidating corporation, the tax consequences are also framed by the rules of complete liquidation. The distribution of assets to shareholders is treated as a sale of those assets at their fair market value, which can result in the corporation recognizing a gain or loss. To settle its tax liabilities, the corporation must file a final income tax return, Form 1120, and file Form 966, Corporate Dissolution or Liquidation, with the IRS.