What’s the Difference? Liquidation vs. Dissolution

An anomaly described in a recent IRS ruling says there is a big, but subtle, difference.

Something else to consider is that under Section 336(a) of the tax code, a gain or loss is recognized by a liquidating corporation on the distribution of its property in complete liquidation, as if such property were sold to the distributee at its fair market value. In other words, in most cases, the liquidation of a corporation commonly engenders two levels of taxation: tax will be imposed at both the corporate and distributee shareholder levels.*

The De Facto Company Closure

A complete liquidation is not always accompanied by a formal or legal company shutdown. According to Section 1.332-2(c) of the tax code, “…legal dissolution is not required…” What’s more, a related revenue rule (Rev. Rul. 54-518, 1954-2 C.B. 142 ) states that “…where a corporation ceases business operations, has retained no assets, has no income, and has actually liquidated, there is in effect a de facto dissolution, even though the corporation has not been formally dissolved…”

In addition, it is entirely possible for the corporation to continue in existence even though it has been, as a matter of state law, dissolved.

Thus, unless dissolution brings about an automatic transfer of the corporation’s assets to its shareholders, the corporation, even though dissolved, continues its existence. Accordingly, the continuation of existence, after dissolution, may well depend on whether the governing state law provides that a dissolved corporation can still own assets.

If state law allows a dissolved company to own assets, the dissolution, unless accompanied by an actual conveyance of the entity’s assets to its shareholders, will not give rise to a liquidation. Indeed, in that situation, the tax consequences spelled out in ( Section 331(a) and Section 336(a) will not be visited on the shareholders and the corporation, respectively.**

Federal Law Governs

The ruling concludes that the “core test of corporate existence,” for purposes of federal income taxation, is always, a matter of federal law. To be sure, since the state law in the IRS example brought about an automatic transfer (to its shareholders) of a dissolved corporation’s assets, it followed that the company’s dissolution did not give rise to a complete liquidation.

So, the ruling concludes that the dissolution and reincorporation did not result, respectively, in a distribution or transfer of the corporation’s properties. In addition, the dissolution and reincorporation will not affect its shareholders’ bases and holding period in its stock. More to the point, notwithstanding the dissolution and reincorporation, no new corporation is deemed to come into existence so the corporate taxpayer is not required to apply for a new Employer Identification Number.

For that reason, it is well-settled that a liquidation can occur without a formal or legal dissolution and, now, thanks to LTR 200806006, we also know that a dissolution—which does not give rise to an automatic transfer of the dissolved corporation’s assets to its shareholders—also does not give rise to, in and of itself, a complete liquidation.

Discuss

Your email address will not be published. Required fields are marked *