In this video, we walk through 5 TCP practice questions teaching about liquidating distributions from C corporations. These questions are from TCP content area 2 on the AICPA CPA exam blueprints: Entity Tax Compliance.
The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.
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Liquidating Distributions from C Corporations
Liquidation of a C corporation involves the distribution of the corporation’s assets to its shareholders and the dissolution of the corporation. Understanding how to calculate the tax realized and recognized gain (loss) for both the corporation and its shareholders is crucial.
C Corporation’s Gain (Loss) Recognition
When a C corporation undergoes liquidation, it must recognize gain or loss as if it sold the distributed property to the shareholders at fair market value (FMV) immediately before the distribution. The gain or loss is calculated as follows:
Gain (Loss) = FMV of Property – Adjusted Basis of Property
Example:
Clearwater Corp. is liquidating and distributes the following assets to its shareholders:
- Inventory with an FMV of $400,000 and an adjusted basis of $250,000.
- Equipment with an FMV of $250,000 and an adjusted basis of $100,000.
- A building with an FMV of $500,000 and an adjusted basis of $300,000.
Calculation:
For inventory: Gain = $400,000 – $250,000 = $150,000
For equipment: Gain = $250,000 – $100,000 = $150,000
For the building: Gain = $500,000 – $300,000 = $200,000
Total gain recognized by Clearwater Corp. is $500,000.
Shareholders’ Gain (Loss) Recognition
Shareholders must recognize gain or loss based on the difference between the FMV of the assets received and their basis in the corporation’s stock. The holding period of the stock determines whether the gain or loss is long-term or short-term.
Gain (Loss) = FMV of Assets Received – Basis in Stock
Example:
Maria owns 200 shares of Seaside Corp. with an adjusted basis of $300,000. Upon liquidation, she receives inventory with an FMV of $350,000 and equipment with an FMV of $200,000.
Calculation:
Total FMV of assets received: Total FMV = $350,000 + $200,000 = $550,000
Gain recognized by Maria: Gain = $550,000 – $300,000 = $250,000
Since Maria held the shares for more than one year, the gain is classified as a long-term capital gain.
Shareholders’ Basis in Property Received
The basis of property received by the shareholders in a liquidation is the FMV of the property at the time of the distribution.
Example:
John owns shares of Ocean Corp. with an adjusted basis of $150,000. During liquidation, John receives property with an FMV of $220,000.
Calculation:
John’s basis in the property received is the FMV at the time of distribution: Basis in property = $220,000
Detailed Example of Liquidating Distribution
Example:
Sunset Corp., a C corporation, is undergoing complete liquidation. The corporation’s assets include:
- Inventory with an FMV of $300,000 and an adjusted basis of $150,000.
- Equipment with an FMV of $200,000 and an adjusted basis of $80,000.
- Land with an FMV of $400,000 and an adjusted basis of $250,000.
C Corporation’s Gain Calculation:
For inventory: Gain = $300,000 – $150,000 = $150,000
For equipment: Gain = $200,000 – $80,000 = $120,000
For land: Gain = $400,000 – $250,000 = $150,000
Total gain recognized by Sunset Corp. is $420,000.
Shareholder’s Gain Calculation:
David owns 300 shares of Sunset Corp. with a basis of $200,000. During the liquidation, David receives the inventory and equipment.
Total FMV of assets received by David: Total FMV = $300,000 (inventory) + $200,000 (equipment) = $500,000
Gain recognized by David: Gain = $500,000 – $200,000 (basis in stock) = $300,000
David held the shares for more than one year, the gain is classified as a long-term capital gain.
Basis in Property Received:
David’s basis in the inventory and equipment received would be their FMV at the time of distribution:
- Basis in inventory: $300,000
- Basis in equipment: $200,000
Conclusion
Calculating the tax realized and recognized gain (loss) for both a C corporation and its shareholders in a liquidating distribution involves understanding the FMV of distributed assets, the adjusted basis of those assets, and the adjusted basis of the shareholder’s stock. Properly applying these principles ensures accurate tax reporting and compliance with tax regulations.
