Deferring shareholder gain by distributing installment notes.

• Author: Ellentuck, Albert B.

WHEN A C CORPORATION SELLS SOME or all of its assets during the process of liquidation and takes back one or more installment notes as payment, it must recognize, in the year of liquidation, all unrecognized gains on installment receivables distributed to the shareholders (Secs. 336 and 453B(a)). The gain recognized is the difference between the fair market value (FMV) of the installment receivable on the date of distribution and the corporation's tax basis in the receivable. This same rule applies to installment obligations arising from sales occurring before the liquidation plan was adopted.

Timing of Shareholder Gain Recognition

Shareholders who receive post-liquidation installment obligations (those arising from sales entered into on or after the date of adoption of the liquidation plan) can defer gain until payment is received on those installment obligations (Sec. 453(h)(1)(A)). In essence, the shareholder treats the installment payments as additional consideration for the stock when they are received. However, this treatment is available only if:

1. The installment obligation is created during the 12-month period beginning with the date of adoption of the liquidation plan; and

2. The liquidation is completed during that 12-month period.

   Observation: The timing of the corporate-level installment sale and the completion of the liquidation process are critical. If the timing rules are not met, the shareholder is forced to treat the full FMV of the installment obligation as received in the year of liquidation. The probable result is that gain will be recognized without the accompanying cash needed to pay the tax.

   Shareholders who receive these installment obligations report any gain or loss on their stock that is attributable to such obligations on the installment basis, unless they elect out of installment reporting.

   If assets sold on the installment method in the post-liquidation period are inventory-type assets (including stock in trade or assets held for sale in the ordinary course of business), they must be sold in a bulk sale or gain will have to be recognized by the shareholder when the installment obligation is distributed (Sec. 453(h)(1)(B)).

   Calculating Shareholder Gain

   To calculate the gain on a post-liquidation installment obligation received, the shareholder's basis in the stock surrendered is allocated among all the assets received (i.e., installment note, cash, property) in proportion to those assets' FMVs. The installment...