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TCP CPA Practice Questions Explained: Liquidating Distributions from C Corporations

Liquidating Distributions from C Corporations

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In this video, we walk through 5 TCP practice teaching about liquidating distributions from C corporations. These questions are from TCP content area 2 on the AICPA CPA exam blueprints: Entity Tax Compliance.

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Liquidating Distributions from C Corporations

Liquidation of a C corporation involves the distribution of the corporationā€™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 corporationā€™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 corporationā€™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 Corporationā€™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.

Shareholderā€™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:

Davidā€™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.

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