Category: Corporations
Subject: Personal Holding Company Income
Title: Effect of Liquidating Distribution on UPHCI
IRC Sections: 562(b)(1), 316(b)(2)(B)
Filename: 1190.html
Date Produced: 12/96

Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com

Issue
Does a liquidating distribution reduce undistributed personal holding company income (UPHCI) for purposes of computing the personal holding company tax?

Answer
For a noncorporate shareholder, a liquidating distribution does reduce undistributed personal holding company income for purposes of computing the personal holding company tax. However, such distributions are then treated as ordinary dividends to the recipient shareholder.

Discussion
On the surface, it might seem undesirable to forgo capital gain treatment on a portion of a liquidating distribution. However, the tax effect of losing the capital gain differential could be less than net effect of the personal holding company tax inside the corporation reduced by the capital gain savings at the shareholder level.

IRC Section 562(b)(1) provides the general rule that a distribution in complete liquidation does not count for purposes of the dividends paid deduction of a personal holding company. IRC Section 316(b)(2)(B) provides a means of allowing a liquidating corporation to make actual dividend distributions in the context of a liquidation in order to eliminate or reduce the personal holding company tax.

In order to take advantage of this rule, the liquidating corporation must do the following.

-Adopt a plan of complete liquidation. In general, this means the board of directors will meet and resolve to liquidate the corporation within a certain period of time. In this case it is necessary to resolve to liquidate promptly but in no case later than 24 months after adoption of the plan. In any case, the liquidation should be carried out in accordance with local corporate law. As with any liquidation, it is necessary to file Form 966 within 30 days after adoption of the plan of liquidation.

-Actually distribute all assets and completely liquidate within 24 months after adoption of the plan of liquidation.

-Designate some (or all) of the liquidating distribution as an ordinary dividend. The amount so designated cannot exceed the shareholder's portion of UPHCI. The distributee (i.e., the shareholder) must be notified of the designation.

The regulations at Section 1.316-1(b)(5) provide the means of making the necessary designation. The corporation should:

(1) claim a dividends-paid deduction for such amount on its return (Schedule 1120 PH) for the year in which, or in respect of which, the distribution is made;

(2) include such amount as a dividend on the Form 1099 filed for the shareholder pursuant to Section 6042(a) and also in the written statement of dividend payments furnished to the shareholder pursuant to Section 6042(c) (the statement may be a copy of the Form 1099); and

(3) indicate on the statement furnished to the shareholder the amount included in such statement as a dividend that is a dividend designated under Section 316(b)(2)(B).

I have attached various sample documents. Please note that these documents were apparently prepared in accordance with the corporate laws of another state and are included here solely for the purpose of illustration. A competent attorney in your jurisdiction should be consulted for the particular requirements of your state.

In addition, please note that it is necessary to completely liquidate within 24 months of adoption of the plan. Since a corporation is created in accordance with local law, it must be liquidated in accordance with that same law. In general, a liquidation is not complete for tax purposes until it is complete under local law. Many states impose potentially time consuming requirements on liquidating corporations such as the need to obtain tax clearance from state revenue authorities before the secretary of state will sanction the dissolution of the corporation. In some states, this can be a lengthy process sometimes even involving an audit by state revenue authorities. Again, a competent attorney in your state should be consulted.