Breaking Up Corporations

Breaking Up Corporations


In this Expert Commentary, Neil Harl describes the challenges involved in the liquidation of farm and ranch business organizations, where there are typically substantial amounts of appreciated assets, such as farmland, that are eligible for long-term capital gains treatment.
 
Mr. Harl writes: The first thought, typically, especially where none of the heirs is interested in carrying on the farm or ranch operation (or even managing the land under a landlord-tenant relationship) is to liquidate the corporation. The reality of a substantial income tax bill, even with the best of planning efforts, often quashes that strategy.
 
In general, liquidation of a C corporation triggers two separate tax events—(1) gain or loss is recognized to a liquidating corporation on the distribution of property in complete liquidation as if the property had been sold to the distributee at its fair market value and (2) gain or loss is recognized to the shareholders measured by the difference between the income tax basis of their stock and the value of the distribution.8 The provisions did not apply to liquidations completed before January 1, 1989, if the value of the corporate stock was $5,000,000 or less and, as of August 1, 1986, and at all times thereafter, more than 50 percent (by value) of the stock of the corporation was held by 10 or fewer individuals, estates or some types of trusts. The two-year grace period after enactment of legislation in 1986 essentially terminating taxfree corporate liquidations was meant to provide an opportunity for small, closely-held corporations to liquidate without heavy income tax liability.
 
The first level of tax, at the corporate level, generally results in a substantial tax to the corporation. In addition to all of the recapture consequences—recapture of depreciation on real property and personal property, recapture of soil and water conservation expense deductions, and government cost-sharing payments, the rule disallowing a deduction for production expenses for unharvested crops transferred to one person in one transaction appears to apply. Moreover, the entire gain is ordinary income inasmuch as the special rates (for individual taxpayers) for long-term capital gain (including the zero rate for the lowest two brackets for 2008, 2009 and 2010) and the 15 percent rate otherwise were not extended to corporate taxpayers. [footnotes omitted]