Chapter 6, Problem 61 – LO.4,5 The stock of Magenta Corporation is owned by Fuchsia Corporation (95%) and Marta (5%).

Magenta is liquidated in the current year, pursuant to a plan of liquidation adopted earlier in the year. In the liquidation, Magenta
distributes various assets worth $950,000 (basis of $620,000) to Fuchsia (basis of $700,000 in Magenta stock) and a parcel of
land worth $50,000 (basis of $75,000) to Marta (basis of $30,000 in Magenta stock). Assuming that the § 338 election is not
made, what are the tax consequences of the liquidation to Magenta, Fuchsia, and Marta?

NOTES

See page 6-21 – 6-27

§ 332—In liquidation of a subsidiary, no gain or loss is recognized by the parent. Subsidiary must distribute all of its property
within the taxable year or within three years from the close of the taxable year in which the first distribution occurs. Minority
shareholders are taxed under the general rule of § 331.

§ 331—The general rule provides for gain or loss treatment on the difference between the FMV of property received and the basis
of the stock in the corporation. Gain allocable to installment notes received can be deferred to the point of collection.

6-9c: Parent-Subsidiary Liquidations

The nonrecognition provision applicable to the liquidation of a subsidiary, § 332, is not elective. Nevertheless, some flexibility may
be available.

Whether § 332 applies depends on the 80 percent stock ownership test. A parent corporation may be able to avoid § 332 by
reducing its stock ownership in the subsidiary below this percentage to allow for recognition of a loss. On the other hand, the
opposite approach may be desirable to avoid gain recognition. A corporate shareholder possessing less than the required 80
percent ownership may want to acquire additional stock to qualify for § 332 treatment.

Once § 332 becomes effective, less latitude is allowed in determining the parent’s basis in the subsidiary’s assets. Generally, the
subsidiary’s existing basis in its assets carries over to the parent. If a timely § 338 election is made, the subsidiary’s basis in its
assets is stepped up to reflect, in part, the parent’s basis in the subsidiary stock. If the subsidiary also is liquidated, the parent
obtains assets with the stepped-up basis.

An election to have the § 338 rules apply should be carefully weighed since the election can be detrimental. The income tax
liability on the subsidiary’s recognized gain that results from the deemed sale of its assets is the cost under § 338 for obtaining the
stepped-up basis. As a result, a § 338 election may be a viable option only when the subsidiary possesses loss and/or credit
carryovers that can be used to offset the associated tax.

As discussed above, the liquidation of a subsidiary generally is a nontaxable transaction resulting in the nonrecognition of gain
or loss for both the parent and the subsidiary corporations and the carryover of the subsidiary’s asset bases (and other tax
attributes).
- Fuchsia owns 95% of Magenta  Fuchsia is the parent of Magenta
- Magenta distributes various assets worth $950,000 (basis of $620,000) to Fuchsia
 Assets: $950000 - $620000 = $330000
 Magenta recognizes no gain or loss recognized on distribution of assets to Fuchsia
- Magenta distributes a parcel of land worth $50,000 (basis of $75,000) to Marta
 Assets: $50000 - $75000 = ($25000)
 The parcel of land Magenta distributed to Marta results in a $25000 nonrecognized loss
- Fuchsia recognizes no gain or loss in the liquidation
- Fuchsia has a carryover basis of $620000 in the assets received
- Magenta’s tax attributes (E&P) carryover to Fuchsia
- Fuchsia’s basis in the Magenta stock disappears
- Under Section 331: The general rule provides for gain or loss treatment on the difference between the FMV of property
received and the basis of the stock in the corporation. Gain allocable to installment notes received can be deferred to the
point of collection. FMV (amount realized – Basis of Stock = Gain recognized in liquidation
 $50000 - $30000 = $20000 Gain recognized in liquidation by Marta
- Marta has a basis in the land of $50000

Magenta no gain or loss recognized on distribution to Fuchsia, $15,000 gain recognized on distribution to Marta; Fuchsia
no gain or loss recognized and basis of $820,000; Marta $40,000 gain recognized and basis of $90,000.
Magenta recognizes no gain on the distribution of assets to Fuchsia, its parent corporation. The land
distribution to Marta results in a $25,000 nonrecognized loss [$50,000 (fair market value) -$75,000 (basis)] to
Magenta.Fuchsia recognizes no gain or loss in the liquidation, and it has a carryover basis of $620,000 in the
assets received. Magenta’s tax attributes (e.g., E & P) carry over to Fuchsia. Fuchsia’s basis in the Magenta stock
disappears.Marta recognizes a $20,000 gain [$50,000 (amount realized) -$30,000 (basis of stock)] in the liquidation, and
she has a basis in the land of $50,000.

Liquidation
Liquidation is a process of selling off all the non-cash assets of the company to generate cash and pay-off all its debt to creditors
and its owners. This happens when the company becomes insolvent.
Magenta
Assets: $950,000 - $620,000 = $330,000