Section 337: Tax Rules for Corporate Liquidations

A corporate liquidation under Section 337 of the Internal Revenue Code allows a subsidiary to distribute its assets to a parent company without an immediate tax liability. This provision facilitates the simplification of corporate structures by preventing a double layer of taxation when a subsidiary is absorbed into its parent. Without this rule, the subsidiary would first pay tax on the appreciated value of its assets upon distribution.

The primary function of this tax rule is to treat the intercorporate transfer of assets as a non-event for tax purposes. This allows for the tax-free movement of property to the parent corporation, deferring the tax until the parent eventually sells or disposes of the assets to a third party.

Qualifying for Tax-Free Treatment

For a liquidation to receive tax-free treatment, two primary conditions must be satisfied. The first is a control requirement, governed by Internal Revenue Code (IRC) Section 332. The parent must own stock in the subsidiary that possesses at least 80% of the total voting power and has a value equal to at least 80% of the total value of all the subsidiary’s stock. This ownership threshold must be met on the date the plan of liquidation is adopted and maintained until the final distribution is received.

The second condition is the “complete liquidation” requirement, which dictates the timing of asset distributions. The subsidiary must distribute all of its property in complete cancellation or redemption of all its stock. This distribution can follow one of two timelines, the first being a transfer of all property within a single taxable year.

Alternatively, distributions can be a series of payments under a formal plan of liquidation. The plan must specify that all property will be transferred within three years from the close of the taxable year in which the first distribution is made. If the corporation fails to meet this deadline, or if the parent fails to maintain 80% control, the tax-free provisions will be retroactively disallowed for all distributions.

Tax Impact on the Liquidating Subsidiary

The primary benefit of this type of liquidation is that the subsidiary recognizes no gain or loss on the distribution of property to its 80% parent corporation. This nonrecognition rule prevents a corporate-level tax on any appreciation in the value of the subsidiary’s assets.

This favorable treatment has important exceptions. One relates to distributions made to minority shareholders. When the subsidiary distributes appreciated property to these minority owners, it must recognize a gain as if the property were sold at its fair market value. Conversely, if the property distributed to minority shareholders has a built-in loss, the subsidiary is not permitted to recognize that loss.

Another area involves the subsidiary’s debts to the parent corporation. If the subsidiary transfers property to the parent to satisfy an existing debt, this transfer is treated as a liquidating distribution for nonrecognition purposes. This means the subsidiary does not recognize a gain or loss on using appreciated property to pay off a debt to its parent during the liquidation.

The nonrecognition treatment does not apply if the parent corporation is a tax-exempt organization, unless the property is used in an unrelated trade or business. This exception prevents taxable corporations from avoiding corporate-level tax by transferring appreciated assets to a tax-exempt parent. In such cases, the subsidiary would be required to recognize gain or loss on the asset transfer.

Tax Impact on the Parent Corporation

The parent corporation recognizes no gain or loss on the receipt of property in a complete liquidation of its 80%-owned subsidiary. This ensures the parent does not have an immediate taxable event from absorbing its subsidiary. The parent’s basis in the subsidiary’s stock effectively disappears without being used to offset any gain.

A defining feature of this transaction is the basis the parent corporation takes in the assets it receives. Under IRC Section 334, the parent takes a carryover basis in the distributed assets. This means the parent’s basis in each asset is the same as the subsidiary’s basis in that asset immediately before the liquidation, preserving any built-in gain or loss.

The carryover basis has significant future implications. For any depreciable assets received, the parent will continue to calculate depreciation based on the original, carried-over basis. If the parent later sells one of the acquired assets, the preserved built-in gain will be recognized at that time, ensuring the appreciation is eventually taxed.

Required Information and Plan of Liquidation

The process begins with the adoption of a formal plan of liquidation, accomplished through a resolution adopted by the corporation’s shareholders. This plan should clearly state the corporation’s intent to liquidate completely and outline the intended timeline for distributing all assets. After adopting the plan, the corporation must notify the IRS by filing Form 966, Corporate Dissolution or Liquidation.

To complete this form, specific information must be gathered:

• The corporation’s name and Employer Identification Number (EIN)
• The date and place of incorporation
• The date the resolution or plan of liquidation was adopted
• Information about the company’s final tax year
• The IRS service center where its last income tax return was filed

A certified copy of the adopted plan of liquidation, along with any subsequent amendments, must be attached to the filed Form 966.

The Filing and Reporting Process

The completed Form 966 must be filed with the IRS service center where the corporation files its income tax returns. This filing must occur within 30 days after the plan of liquidation is adopted. If the plan is amended after the initial filing, another Form 966 must be filed within 30 days of the amendment.

In addition to Form 966, the liquidating subsidiary is required to file a final federal income tax return, Form 1120, for its last taxable year. On this final return, the corporation must check the box indicating it is a “final return.” The due date for this return is the 15th day of the fourth month after the corporation dissolved.

Both the parent and the subsidiary must maintain detailed records of the transaction. Both corporations must attach statements to their federal income tax returns for the year in which the liquidation occurs. These statements must provide details about the liquidation, including a copy of the plan, a list of the properties distributed with their fair market values and basis, and a statement of any indebtedness between the parent and subsidiary.