Like most things, there is a time when a corporation must come to an end. This may be because a business is sold or discontinued, or the corporation otherwise no longer serves a useful purpose. State law governs the dissolution procedures for a corporation, and hence the available procedures may vary in significant respects depending on the state of organization (under Delaware law, for example, a corporation may opt for “long-form” dissolution which involves notifying potential claimants and may foreclose post-dissolution claims against directors).

From a tax perspective, unless certain conditions under Internal Revenue Code section 332 are satisfied, upon liquidation a corporation is taxed on any appreciation in its assets and its shareholders are taxed on any appreciation in the corporation’s stock. This accords with the intended double taxation scheme of engaging in business in corporate form. Of course, this is different from partnerships, which can be dissolved with one level of taxation (or possibly without current taxation if partnership assets are simply distributed in kind to the partners).

Generally under Code sections 332 and 337, a corporation that is at least 80% owned by a domestic corporate shareholder can distribute assets to its corporate shareholder tax-free (to both the corporation and the shareholder) in a complete liquidation. If the shareholder is a foreign corporation, then the tax-free liquidation provisions apply only under limited exceptions – such as in the event that the foreign corporate shareholder receives in the liquidation U.S. real property interests, or 80% or more of the shares in a domestic subsidiary, or assets used in a U.S. trade or business which the shareholder continues for 10 years following the liquidation (with the result that the foreign corporation continues to pay U.S. tax in respect of such U.S. trade or business). If the exceptions do not apply, it would be important to determine the U.S. taxable gain, if any, in the assets and stock of a corporation to be liquidated.

Rescinding a transaction

Separately from corporate liquidations, there may be instances where parties have engaged in a transaction such as a sale of property and subsequently decide to “undo” or rescind the transaction. The question arises whether the transaction can be unwound without tax consequence. If the parties are viewed for tax purposes as having engaged in two separate transactions (the second one being the unwinding transactions), then there would potentially be two instances of tax, contrary to the parties’ intent. While the taxation of rescission transactions is not entirely established, case law and IRS private rulings have provided that the tax consequence of a transaction can be “taken back” in an effective rescission of the transaction, particularly where the rescission occurs in the same taxable year as the initial transaction.