PORTFOLIO

Collapsible Corporations (Portfolio 793)

Tax Management Portfolio, Collapsible Corporations, No. 793, discusses the purpose of the collapsible corporation provisions and analyzes in depth the legal principles applicable to former §341. The collapsible corporation provisions under former §341 were permanently repealed by the American Taxpayer Relief Act of 2012 (2012 ATRA), P.L. 112-240, §102(a). The provisions were originally repealed on a temporary basis by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), P.L. 108-27, §302(e)(4). The repeal was subject to JGTRRA's sunset provision, P.L. 108-27, §303, which provided that the repeal would expire at the end of 2010, but the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 TRA), P.L. 111-312, §102, amended the JGTRRA sunset provision to postpone expiration until December 31, 2012. The 2012 ATRA, §102(a), removes the JGTRRA sunset provision altogether, thereby making repeal of the collapsible corporation provisions permanent. The discussion below does not reflect changes made by the 2012 ATRA.

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DESCRIPTION

Tax Management Portfolio, Collapsible Corporations, No. 793, discusses the purpose of the collapsible corporation provisions and analyzes in depth the legal principles applicable to former §341. The collapsible corporation provisions under former §341 were permanently repealed by the American Taxpayer Relief Act of 2012 (2012 ATRA), P.L. 112-240, §102(a). The provisions were originally repealed on a temporary basis by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), P.L. 108-27, §302(e)(4). The repeal was subject to JGTRRA's sunset provision, P.L. 108-27, §303, which provided that the repeal would expire at the end of 2010, but the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 TRA), P.L. 111-312, §102, amended the JGTRRA sunset provision to postpone expiration until December 31, 2012. The 2012 ATRA, §102(a), removes the JGTRRA sunset provision altogether, thereby making repeal of the collapsible corporation provisions permanent. The discussion below does not reflect changes made by the 2012 ATRA. Former §341 was added to the Code to prevent taxpayers from converting ordinary income into capital gain through the use of corporations. In general, if a corporation is a collapsible corporation, as defined in former §341(b), gain to its shareholders upon a sale (or a deemed sale through liquidation) of the corporation's stock, to the extent that it exceeds the basis of such stock, is treated as ordinary income (thus, converting what would normally be capital gain into ordinary income).
The Tax Reform Act of 1986 substantially reduced the importance of former §341 for post-1986 years by repealing the General Utilities doctrine — it is no longer possible to avoid corporate level tax when liquidating a collapsible corporation. In addition, the importance of former §341 is also reduced in years in which there is little or no rate differential between ordinary income and capital gains. For years when there is no rate differential between capital gains and ordinary income, the distinction between ordinary income and capital gains, however, may still be relevant for such purposes as offsetting capital losses against capital gains. To ameliorate the application of the collapsible corporation provisions, former §341 provides for several limitations or exceptions to such rules. These relief provisions can be found in former §341(d), (e), and (f). These provisions are extremely complex and a determination of whether relief is provided can only be made after a complete examination of the statutory language and its application to a specific factual situation.
This Portfolio discusses: (1) the definition of a collapsible corporation under former §341(b); (2) the types of transactions subject to former §341, (3) the presumption of collapsible status provided by former §341(c); and (4) the limitations and exceptions to the collapsible corporation rules set forth in former §341(d), (e), and (f).


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AUTHORS

REUVEN S. AVI-YONAH
Reuven S. Avi-Yonah (B.A., Hebrew University, 1983; Ph.D., Harvard University, 1986; J.D., Harvard Law School, 1989) is Assistant Professor of Law, Harvard Law School, where he teaches domestic and international taxation. Mr. Avi–Yonah is a member of the New York and Massachusetts bars and co–chairs the tax policy committee of the New York State Bar Association Tax Section. He participated in preparing the Tax Section's reports on proposed legislation on amortization of intangibles and has published several articles and comments on the leading Supreme Court case in this area, Newark Morning Ledger Co. v. United States, 113 S. Ct. 1670 (1993).

TABLE OF CONTENTS

Detailed Analysis

I. Background of the Collapsible Corporation Provisions

II. Statutory Outline

Introductory Material

A. Basic Principles

1. Pre–1986 TRA Law

2. Post–1986 TRA Law

B. The Definition in Section 341(b)

C. Subjective or Objective Test

D. Case Law

III. Transactions Covered by Section 341

Introductory Material

A. Transactions Referred to in Section 341(a)

B. Redemptions Under Section 302

C. Section 338

IV. Analysis of Elements of Collapsible Corporation Under Section 341(b)

Introductory Material

A. The “Principally” Requirement

B. The Manufacture, Construction, or Production of Property

1. To Any Extent

2. Property Acquired in Tax–Free Transactions

3. The Meaning of Property

4. Nature of the Property Included

5. Definition of “Construction”

a. General Comments

b. Preliminary Activities

c. Retained Interest in Construction

d. Completion of Construction or Production

e. The Effect of Reconstruction

f. Development of Oil Property as Construction

C. The Purchase of Property

1. General

2. Section 341 Assets

a. Inventory–type Property

b. Unrealized Receivables or Fees

c. Section 1231(b) Assets

d. Property Used in Connection with Manufacture

D. Holding Companies

E. The “View to” Requirement

1. General

2. When Must the View Exist?

3. Need for Unanticipated Event

4. The Decisional Law

5. Who Must Have the View?

6. Minority Shareholders and Forced Sales

7. The View to Realization of Gain

8. Sale to Related Person or Co–Shareholder

F. Realization of a Substantial Part

1. Pre–1984 TRA Law - “Substantial Part” Test of Section 341(b)(1)(A)

2. Post–1984 TRA Law - “Two–Thirds” Test of Section 341(b)(1)(A)

3. Taxable Income to be Derived

4. Taxable Income as Opposed to Gross Income

5. Test Applied at Date of Collapse

6. More Than One Property

7. The Integrated Project Rule

8. Special Rule of Regs. Section 1.341–5(c)(2)

9. Computation of Taxable Income Where More Than One Property is Held?

G. Gain Attributable to Such Property

H. Twenty–Year Rule

V. The Rebuttable Presumption of Section 341(c)

Introductory Material

A. General

B. The 120% Provision

C. Holding Company and Manufacturing Company

D. Practical Effect on Presumption

VI. Limitations on Application of Section 341

Introductory Material

A. General

B. The 5% Stock Ownership Rule

C. The 70% Rule of Section 341(d)(2)

1. General

2. Classification of Property

3. Gain Attributable to Collapsible Property

4. Allocation of Deductions

5. Percentage Test to Different Shareholders

6. Single versus Separate Property

7. Aggregation Requirement

8. Land and Building

9. Improvements to Property

D. The Three–Year Rule of Section 341(d)(3)

1. General

2. Tacking of Holding Period

3. When is Construction Completed?

4. More Than One Property

5. Gain Attributable to Three–year Property

6. Deferred Payment Sales

7. Date of Sale

VII. Section 341(e)

Introductory Material

A. Basic Formula and Definitions

1. Net Unrealized Appreciation

2. Net Worth

3. Section 341(e) Assets - Defined

a. General Definition

(1) Ordinary Income Assets

(2) Section 1231(b) Built–in Loss Assets

(3) Section 1231(b) Appreciated Assets

(4) Literary and Artistic Assets

b. Treatment of Section 1231(b) Assets

c. Attribution Rules

d. Recapture and Collapsibility Status Disregarded

4. Specific Shareholder Test

B. Determination of Stock Ownership

1. In General

2. Attribution of Ownership

3. Constructive Shareholders

4. Value of Outstanding Shares

C. Application of Section 341(e) to Stock Sales or Exchanges

1. General Corporate Test

2. Specific Shareholder Test

a. More Than 5% But Not More Than 20% Shareholders

b. More Than 20% Shareholders (the “Hypothetical Dealer Test”)

(1) In General

(2) Related Corporation Defined

(a) Stock Ownership Test

(b) More–than–70% Asset Comparison Test

(3) Manner of Taking into Account Related Corporations

(4) Effect of Taking Related Corporation into Account

(5) Examples

3. Exceptions for Certain Sales to Related Persons

VIII. Section 341(f)

Introductory Material

A. In General - Sales of Stock

B. Form of Consent

1. Statement of Consent

2. Affiliated Corporations Included in Statement

3. Revocability and Termination of Consent

4. Notification Requirements

a. Consenting Corporation

b. Shareholders

5. Foreign Corporations

C. Recognition of Gain

1. General Rule

2. Exception to the Gain Recognition Rules

a. In General

b. Foreign Corporation Transferees

D. Section 341(f) Asset - Defined

1. In General

2. Special Rules - Construction of Property

E. Five–Year Limitation as to Shareholder

F. Special Rule for Stock Ownership in Other Corporations

G. Basis Adjustments

H. Summary - When to Use a Section 341(f) Consent

1. Factors Clearly Indicating that the Consent Should be Filed

2. Factors Clearly Indicating that the Consent Should Not be Filed

3. Conclusion

IX. Interrelationship of Section 341 and the Reorganization Provisions

X. Miscellaneous Observations

Introductory Material

A. Foreign Corporations

B. IRS Ruling Policy


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Case Analysis of Approach to Collapsible Corporation Problem.

Worksheet 2 Checklist of Defenses to Section 341.

Worksheet 3 Tax Planning on Organization of Corporation - Transfer of Appreciated Securities.

Worksheet 4 Use of Multiple Corporations To Avoid the “View to” Rule.

Worksheet 5 Advantages and Disadvantages of a Single Corporation, Depending on the Application of the 70% Rule.

Worksheet 6 Use of Multiple Corporations in Connection With the Three–Year Rule.

Worksheet 7 Taxfree Reorganization as a Method of Avoiding Section 341.

Worksheet 8 Corporate Resolution Authorizing Filing of Section 341(f) Consent.

Worksheet 9 Corporate Resolution Authorizing Transferee Agreement.

Worksheet 10 Corporate Consent to Recognize Gain on Disposition of “subsection (f) assets” (Regs. Section 1.341–7(b)(2)(i)).

Worksheet 11 Notice to IRS that Consenting Corporation Has Become 5% or More Owner of Another Corporation (Regs. Section 1.341–7(b)(2)(ii)).

Worksheet 12 Shareholder Notification (Regs. Section 1.341–7(c)).

Worksheet 13 Notification by Shareholder of Sale of Consenting Corporation's Stock (Regs. Section 1.341–7(d)).

Worksheet 14 Form of Transferee Agreement.

Worksheet 15 Form of Representation That Section 341(f) Consent Has Not Been Filed.

Worksheet 16 Committee Reports Relating to the Enactment of the Collapsible Corporation Provisions.

Worksheet 17 Committee Reports Relating to Section 341(e). Technical Amendments Act of 1958

Worksheet 18 Committee Reports and Joint Committee Explanation Relating to Section 341(f).

Worksheet 19 Joint Committee Explanation Relating to Sections 341(b) and (d).

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Legislative History:

Treasury Rulings:

Cases:

UNOFFICIAL

Treatises:

Periodicals:

1986

1987

1990

1994

1995

1997