Corporate Distributions After the Tax Reform Act of 1984
| Publication year | 1985 |
| Pages | 1755 |
1985, October, Pg. 1755. Corporate Distributions After The Tax Reform Act of 1984
In a previous article, published in December 1982, the tax aspects of liquidating a corporation were explored, including changes made by the Tax Equity and Fiscal Responsibility Tax Act of 1982 ("TEFRA").(fn1) The Tax Reform Act of 1984 ("1984 TRA") made further changes and has created a need for an update.(fn2) This article provides such an update and also considers the tax treatment of both liquidating and non-liquidating distributions of property (other than money) by a corporation with respect to its stock.
This and the 1982 article together should provide the general practitioner with an overview of the tax treatment at both the corporate and shareholder levels when property is distributed to shareholders as a dividend, in redemption of stock or in partial or complete liquidation of the corporation. Those requiring a more in-depth analysis of particular aspects of a transaction have numerous other sources at their disposal, many of which are listed in the footnotes.(fn3)
Prior to 1954, the tax treatment of a corporation that distributed assets to shareholders was the exclusive province of the Treasury regulations, since there was no statutory provision. In 1919, these regulations provided that "no gain or loss is realized by a corporation from the mere distribution of its assets in kind upon dissolution, however they may have appreciated or depreciated in value since their acquisition."(fn4) This general rule is known as the General Utilities doctrine, after the 1935 case of that name, and was codified as § 336 of the Internal Revenue Code in 1954 ("Code").(fn5)
The same general rule, with exceptions, applies to non-liquidating distributions. Code § 311 (a) provides that "...no gain or loss shall be recognized to a corporation on the distribution, with respect to its stock, of (1) its stock (or rights to acquire its stock), or (2) property." With respect to liquidating distributions, Code § 336(a) provides that "...no gain or loss shall be recognized to a corporation on a distribution of property in complete liquidation." However, between the 1919 regulation and the 1984 TRA lies an enormous body of statutory and case law which, according to a leading casebook on taxation, contains "a complex pattern of exceptions and exceptions to the exceptions which follow no rational thread."(fn6)
The exceptions to non-recognition treatment at the corporate level upon liquidation include: (1) the distribution of property subject to depreciation recapture; (2) acceleration of gain upon the disposition of installment obligations; (3) assignment of income and clear reflection of income doctrines; and (4) application of the tax benefit rule.(fn7)
Code § 311(d) also provides several exceptions to non-recognition of gain in a non-liquidating distribution of property. The distributing corporation must recognize gain on a distribution of LIFO inventory to the extent of the excess of the FIFO value over the LIFO value of the distributed property. As amended by the 1984 TRA, Code § 311(d)(1) now requires recognition of gain by the corporation upon a distribution of appreciated property with respect to its stock. This is an exception to the general rule of non-recognition contained in Code § 311(a), and it is at this point that several exceptions to the exceptions come into play.
The Code § 311(d)(1) exception will not apply---and thus the general rule of § 311(a) will apply---to a distribution of appreciated property to an individual shareholder with respect to "qualified stock" in a distribution qualifying as a "partial liquidation."(fn8) Other exceptions to the exception include the following: (1) a distribution that is a "qualified dividend";(fn9) (2) a distribution of the stock of a controlled subsidiary to an individual shareholder if the requirements of Code § 311(e)(2) are met; (3) a distribution in redemption of stock pursuant to Code § 303 to pay death taxes; (4) a distribution in redemption of stock to a private foundation; and (5) a distribution by a regulated investment company.
A corporation always recognizes gain on a distribution of installment obligations, except for obligations acquired in a sale of assets under a Code § 337 twelvemonth liquidation. All of the recapture provisions discussed in the previous article, which override Code §§ 336 and 337, also override § 311.(fn10)
The application of these rules and their exceptions may be illustrated by an example. Suppose that a corporation which operates two restaurant businesses decides two distribute one of the restaurants to its shareholders, who then attempt to find a buyer for the business. The desired tax result is for the shareholders to obtain capital gain treatment on the distribution with no recognition of gain at the corporate level. Assuming the Court Holding doctrine will not attribute the sale back
If the current value of the business distributed exceeds the corporation's adjusted basis, the Code § 311(d) exception to the general rule of § 311(a) could trigger recognition at the corporate level upon distribution. Nevertheless, non-recognition may still be achieved under the following circumstances. First, the shareholders must own "qualified stock," meaning that, during the lesser of the five-year period ending on the date of distribution or the period during which the distributing corporation was in existence, each distributee held at least 10 percent in value of the outstanding stock of the corporation. Second, the distribution must be in redemption of stock of only non-corporate shareholders. Third, the distribution must be pursuant to a plan and occur within the taxable year in which the plan is adopted or within the succeeding taxable year. Finally, the distribution must not be essentially equivalent to a dividend, meaning that a genuine corporate business contraction must occur.
The desired result might also be achieved at the corporate level, but not the shareholder level, if the distribution is a "qualified dividend." A qualified dividend occurs if the business distributed was actively conducted by the corporation throughout the five-year period ending on the date of the distribution; was not acquired by any person within such period in a taxable transaction; and is taxed to the shareholders as a dividend. This latter requirement frustrates the shareholders' desire to obtain capital gain treatment on the distribution. Neither inventory nor accounts receivable may be distributed in partial liquidation so as to avoid recognition of gain at the corporate level.
The General Utilities doctrine, now codified in Code §§ 311 and 336, was recognized even before the 1919 regulations.(fn12) The doctrine has undergone substantial change in the past, and the current version is not likely to remain intact for long.(fn13) The Treasury first proposed repeal of the rule in 1948 in a recommendation to the House Ways and Means Committee:
In order to prevent inequity and tax avoidance upon distribution and sale of corporation assets, the appreciation and value of corporate assets, distributed in kind to shareholders of the corporation be taxed as a gain to the corporation.(fn14)
Others since have argued vigorously for repeal of the rule. In 1982, legislation was introduced, but not enacted, that would have required recognition of gain on the distribution of appreciated property in any case where the distributee acquires a fair market value basis in the property.(fn15)
Recently, the staff of the Senate Finance Committee released a report on "The Subchapter C Revision Act of 1985," which, at this writing, had not been introduced. This bill would repeal Code §§ 336, 337, 338 and the collapsible corporation provisions of Code § 341. Code § 311(d), currently an exception to the general non-recognition rule of § 311(a), would become the general rule, and most corporate distributions, both liquidating and non-liquidating, would trigger recognition of gain or loss.
This bill or similar legislation is likely to be eventually enacted because of an apparent concern in Congress and elsewhere that the present system of allowing...
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