Timing liquidation distributions for tax savings.

• Author: Ellentuck, Albert B.

Facts: Jack owns all the stock in Trinity, Inc., a calendar-year S corporation. Trinity has been an S corporation since its 1990 inception. Jack, age 71, contacts his tax adviser in November of the current tax year, stating he would like to liquidate the corporation due to health reasons. * By the end of the current year, Jack expects the corporation to have paid an its liabilities and own $10,000 in cash, equipment with a fair market value (FMV) of $80,000, and land with a FMV of $120,000. The equipment originally cost $100,000 and currently has an adjusted basis of $20,000. The land currently has an adjusted basis of $50,000. * Jack's sole source of income has been his salary and distributions from Trinity. For 1998, Trinity expects to realize net income of $10,000 after paying Jack a salary of $80,000 for the year. Trinity normally distributes its entire net income to Jack annually. At the beginning of the year, Jack's stock basis was $55,000 and Trinity's accumulated adjustments account (AAA) was zero. Jack does not expect to work after the corporation is liquidated, but expects to have taxable retirement income of about $30,000 beginning in 1999. * Jack states he has separate buyers for the equipment and real estate. The sales price is expected to equal the FMVs indicated. The buyers are flexible as to the timing of the proposed sales. Issue: What are Jack's options and how should he proceed in liquidating the corporation?

Analysis

* Complete Liquidation in the Current Tax Year

Jack has at least two options in proceeding with the liquidation. Trinity can adopt a plan of compete liquidation under Sec. 331(a) to distribute all assets to Jack in the current year in a liquidating distribution in exchange for his stock. The cash will not be included in the liquidating distribution, but instead will be distributed under the normal distribution rules of Sec. 1368. If this plan is followed, Trinity recognizes a gain or loss on the distribution as if the property had been sold at FMV Thus, Trinity would recognize a gain of $130,000 ($200,000 -- $20,000 -- $50,000). Of this amount, $60,000 is ordinary income from Sec. 1245 recapture, and $70,000 is long-term capital gain. The gain and Trinity's $10,000 net income for the year pass through and increase Jack's stock basis to $195,000 ($55,000 + $10,000 + $130,000). The cash distribution will reduce AAA and stock basis by $10,000. After the cash distribution, stock basis will be $185,000. Jack...