Key Takeaways
- Complete liquidation results in double taxation.
- Corporation recognizes gain/loss on asset distributions (§336).
- Shareholders recognize capital gain/loss (FMV - basis) (§331).
- Parent-subsidiary liquidation (80%+) is tax-free under §332.
- Subsidiary transfers assets at carryover basis under §334.
- Liquidating distributions are treated as full payment for stock.
Corporate Liquidation
Why This Matters for the Exam
Liquidation is the final chapter for a C corporation—and it triggers double taxation (with exceptions). The exam tests the general rules and the parent-subsidiary exception.
Expect at least 3-4 questions on liquidation.
What Is a Complete Liquidation?
A complete liquidation occurs when a corporation:
| Step | Action |
|---|---|
| 1 | Ceases business operations |
| 2 | Distributes all assets |
| 3 | Cancels all stock |
| 4 | Dissolves the entity |
Double Taxation on Liquidation
| Level | Tax |
|---|---|
| Corporate level (§336) | Gain/loss on asset distribution |
| Shareholder level (§331) | Capital gain/loss on stock surrender |
Corporate-Level Tax (§336)
The corporation recognizes gain or loss as if it sold all assets at FMV:
| Rule | Treatment |
|---|---|
| Gain | Recognized |
| Loss | Recognized (with exceptions) |
| Related party losses | May be disallowed |
§336 Example
| Item | Amount |
|---|---|
| Asset basis | $100,000 |
| Asset FMV | $180,000 |
| Corporate gain | $80,000 |
| Tax (21%) | $16,800 |
Shareholder-Level Tax (§331)
Shareholders recognize capital gain or loss:
| Formula | Calculation |
|---|---|
| Amount received (FMV) | $X |
| - Stock basis | -$Y |
| = Capital gain/loss |
§331 Example
| Item | Amount |
|---|---|
| Asset FMV received | $180,000 |
| After corporate tax | $163,200 |
| Shareholder's stock basis | $50,000 |
| Capital gain | $113,200 |
| Tax (20% rate) | $22,640 |
Combined Tax Burden
| Level | Tax |
|---|---|
| Corporate | $16,800 |
| Shareholder | $22,640 |
| Total | $39,440 |
| Effective rate | 49.3% on $80,000 gain |
Parent-Subsidiary Liquidation (§332)
Exception: If a parent owns 80%+ of subsidiary, liquidation is tax-free.
| Requirement | Detail |
|---|---|
| Ownership | Parent owns 80%+ of voting + 80%+ of value |
| Complete liquidation | All assets distributed |
| Timing | Within one tax year (or per adoption plan) |
§332 Treatment
| Level | Treatment |
|---|---|
| Subsidiary (§337) | No gain/loss recognized |
| Parent (§332) | No gain/loss recognized |
| Basis (§334) | Parent takes carryover basis in assets |
§332 Example
| Item | Treatment |
|---|---|
| Parent owns 100% of Sub | Qualifies for §332 |
| Sub's asset basis | $200,000 |
| Sub's asset FMV | $500,000 |
| Sub's gain | $0 (§337) |
| Parent's gain | $0 (§332) |
| Parent's basis in assets | $200,000 (carryover) |
Real-World Scenario
Scenario: A C corporation liquidates. Its only asset is land with basis $50,000 and FMV $150,000. Sole shareholder has stock basis of $60,000.
- Corporate level: Gain = $150,000 - $50,000 = $100,000. Tax = $21,000.
- Net distribution: $150,000 - $21,000 = $129,000.
- Shareholder level: Gain = $129,000 - $60,000 = $69,000. Tax = ~$13,800.
- Total tax: ~$34,800 on $100,000 economic gain.
On the Exam
Expect 3-4 questions on liquidation, typically:
- Corporate Gain Questions: "Corporation liquidates property. What is the gain?"
- Shareholder Gain Questions: "Shareholder receives $X in liquidation. What is the gain?"
- §332 Questions: "When is parent-subsidiary liquidation tax-free?"
The key is to remember: Double tax on liquidation. Corp recognizes gain (§336). Shareholder recognizes CG (§331). Parent-subsidiary (80%+) = tax-free (§332).
Corporation liquidates, distributes property FMV $300k, basis $180k. Corporate gain?
When is parent-subsidiary liquidation tax-free?
In a §332 liquidation, what is the parent basis in assets received?