Check whether Forms 1099-DIV were filed for all shareholders receiving distributions in the amount of $600 or more in a single calendar year. If not, consider the applicability of penalties. Examiners are required to secure all unfiled Forms 1099 and process them through the Submission Processing Center. Consideration should be given to coordinating with Planning and Special Programs (PSP) to determine whether a project should be started on the individual recipients of the Form 1099 income. Generally, these cases are best worked by correspondence or by office examination.

If dividends were paid to foreign parties, verify that Form 1042 was filed.

Verify that Form 966, Corporate Dissolution or Liquidation, was properly filed and inspect the form.

In Rev. Proc. 90-52 the Service issued a checklist questionnaire detailing the information to be included by taxpayers in submitting ruling requests for liquidation of subsidiaries under IRC section 332. Examiners may wish to refer to the checklist as an information source when examining cases involving liquidation issues.

Rev. Rul. 71-129 states that a corporation that has completed liquidation is considered dissolved, and must file its return and pay the tax due thereon for the short period on or before the fifteenth day of the third full month following the dissolution.

The following documents are typically prepared by corporations in the process of liquidating. The examiner should request these documents and inspect them for any irregularities/unusual items:

The determination as to whether and/or when a corporation has liquidated is a question of fact. Proof of a distribution in complete liquidation not only depends on an intent to liquidate but also requires acts which demonstrate and effect that intent.

A corporation in existence during any portion of a taxable year is required to make a return. If a corporation was not in existence throughout an annual accounting period (either calendar year or fiscal year), the corporation is required to make a return for that fractional part of a year during which it was in existence. A corporation is not in existence after it ceases business and dissolves, retaining no assets, whether or not under State law it may thereafter be treated as continuing as a corporation for certain limited purposes connected with winding up its affairs, such as for the purposes of suing and being sued. If the corporation has valuable claims for which it will bring suit during this period, it has retained assets and therefore continues to exist. A corporation does not go out of existence if it is turned over to receivers or trustees who continue to operate it.

TIMING OF LOSS RECOGNITION BY SHAREHOLDER - When a shareholder receives a series of distributions in liquidation, gain is recognized once all of the shareholder's stock basis is recovered. A loss, however, will not be recognized until the final distribution is received [see Rev. Rul. 69-334, 1969-1 C.B. 98, Rev. Rul. 68–348, 1968–2 C.B. 126, and Ethel M. Schmidt, 55 T.C. 335 (1970)].

UNVALUED ASSETS - A taxpayer may advance the position that contingent contract rights/disputed claims/mineral royalties, etc., should not be recognized because an accurate valuation cannot be ascertained [see Burnet v. Logan, 283 U.S. 404 (1931)]. Consideration should be given to referring the valuation of contingent claims to an IRS engineer and/or to obtaining an appraisal. It is rare when an asset cannot be valued.

DISTRIBUTIONS WITH UNKNOWN LIABILITIES - If the amount of a liability distributed is unknown at the time of distribution, or so speculative that it is properly disregarded in computing a shareholder's gain/loss on liquidation, any subsequent payment of the debt by the shareholder should be a capital and not an ordinary loss. This is based upon the theory that the original capital gain on the liquidation was overstated [see Arrowsmith , 344 U.S. 6 (1952)].

DIVIDEND INCOME - A dividend is defined in section 301. IRC section 331(b) holds that IRC section 301 will not apply to a liquidating distribution.

IRC SECTION 1244 STOCK LOSS – IRC section 1244 provides special rules. If stock qualifies as IRC section 1244 stock then the shareholder can claim an ordinary loss instead of a capital loss on the disposition or worthlessness of the stock.

The stock was issued by a domestic corporation which was a " small business corporation" at the time the stock was issued;

The stock was issued by such corporation for money or other property (other than stock and securities), and

The aggregate amount received for the stock was less then $1M; and

The corporation, during the period of its 5 most recent taxable years ending before the date the loss on such stock was sustained, derived more than 50 percent of its aggregate gross receipts from sources other than royalties, rents, dividends, interests, annuities, and sales or exchanges of stocks or securities.

$50,000 or

$100,000, in the case of a husband and wife filing a joint return.

TAX BENEFIT RULE - RECAPTURE OF PRIOR DEDUCTIONS - There may be items of value not appearing in the asset accounts because they were expensed or written-off (e.g., small tools, cattle feed, supplies, etc.). To the extent that these items have a fair market value in excess of their adjusted basis, IRC section 336(a) gain would be recognized. Prior to the 1986 legislative change in IRC section 336, the tax benefit doctrine was invoked to recapture those prior deductions [Hillsboro National Bank v. Commissioner , 460 U.S. 370 (1983)].

FAIR MARKET VALUE (FMV) OF ASSETS - Taxpayers often argue that book value approximates fair market value because tax depreciation is a measure of wear and tear on an asset. Often, a fully depreciated asset will have a higher fair market value than its book value. For instance, a fully depreciated luxury auto with a high resale value. The examiner should be alert to the possibility that the FMV of the assets may greatly exceed the adjusted basis of the assets. Therefore, a gain on disposition should be computed on the corporate return under IRC section 336.

CHARACTER OF GAIN – Examiners should ensure the gain on liquidation has been properly classified. Frequently, all gain on liquidation is not IRC section 1231 gain. IRC section 1231 gain results in capital gain treatment. The gain on liquidation may be ordinary. For example, gain on the sale of inventory.

RECAPTURE - IRC section 291 recapture or IRC section 1245 recapture. The examiner should be alert to the possibility of recapturing depreciation, investment credit and any other recapture provisions that may be applicable to a liquidating corporation. The proper character of gain from a liquidating S corporation is very important because the character of the gain is determined at the entity level and flows through to the shareholder’s return.

LIQUIDATING CORPORATION INCOME - Problems involving the amount of income a liquidating corporation will report during the year of liquidation will frequently arise. Many cash-basis corporations will have substantial accounts receivable, as in the case of professional corporations. Although these receivables may not appear on the books, records of some type will exist to keep track of billings. If IRC section 336(a) does not serve as an argument that all of these receivables are taxable (as in the case where the fair market value of the billings is less than the face value of the receivables), then either the assignment of income or clear reflection of income doctrines should be advanced.
ASSIGNMENT OF INCOME DOCTRINE - This provides that the rights to receive income cannot be distributed to shareholders upon liquidation. Since the corporation is the one that rendered the services for which customers were billed, then the receivables must be taxed to the corporation [see J. Ungar Inc. v. Commissioner, 244 F.2d 90 (2nd Cir. 1957) and Williamson v. United States, 292 F.2d 524 (Ct. Cl., 1961)].
CLEAR REFLECTION OF INCOME DOCTRINE - This argument maintains that in light of the requirement that an accounting method must clearly reflect income [IRC section 446(b)], an accounting method that is acceptable for a continuing business may not be allowable for a liquidating business. A corporation that is on the completed contract method and liquidates when a project is only partially completed must include in income a percentage of the profit on the contract under the percentage completion method [Jud Plumbing & Heating, Inc., 153 F.2d 681 (5th Cir. 1946)].

LOSS RECOGNITION - Examiners should be aware of any assets being contributed by shareholders which result in losses (see IRC section 336(d) for the "anti-stuffing" rules). Also, a liquidation followed by reincorporation of the working assets could be a device to recognize losses. The Government has been successful in establishing that such arrangements constitute a reorganization.

EXPENSE ACCRUALS - Any expense accruals should be recaptured as income if they are forgiven or not paid pursuant to the liquidation. This typically occurs with accruals of interest owed to commonly controlled entities.

COSTS OF REORGANIZATION - If the liquidation is related to a reorganization, the expenses allocated to the cost of the reorganization are not deductible [see Kingsford Corp. v. Commissioner, 41 T.C. 646 (1964, acq. 1964-2 C.B. 6)].

LIQUIDATION COSTS PAID BY SHAREHOLDERS - If a shareholder incurs costs in effecting a complete or partial liquidation, the costs should be classified as capital expenditures. The costs will affect the shareholder's gain or loss upon liquidation (Rev. Rul. 67-411, 1967-2 C.B. 124).

COSTS OF REDEEMING STOCK - IRC section 162(k) specifically provides that no deduction is allowed for any amount paid or incurred by a corporation in connection with reacquisition of its stock. This rule applies to redemptions in partial liquidations per IRC section 302(b)(4) and Income Tax Regulations section 1.346-1(a)(2) [see Bittker and Eustice, paragraph 10.07(3)].

EXPENSES OF ISSUING/RESELLING STOCK - A corporate taxpayer may generally write-off organization and merger expenditures that have been capitalized over the life of the corporation, since they are considered worthless at the date of liquidation. However, the expenses of issuing or reselling stock are never deductible [see McCrory Corp. v. United States, 651 F.2d 828 (2nd Cir. 1981) and Bittker and Eustice, paragraph 5.04(9), footnote 164].

ABANDONMENT LOSSES ON INTANGIBLES - A corporation will frequently claim abandonment losses on intangibles, such as leasehold costs and trademarks, upon liquidation. If the likelihood exists that the items will be used after liquidation, then the assets are not considered worthless and no IRC section 165 loss is available.