Unanticipated refund of C corp expense after liquidation?

[jklcpa]

Stockholder of liquidated C corp was just notified by the electric company about overcharges spanning about 10 years(!) due to a faulty meter.  The overage is being refunded in 2017 to the former stockholder and the amount is not insignificant.  The electric company may have asked my client to provide a W-9. I have to find out about that.

At the moment, I'm not sure what to do with this?  Should the corporation go back and amend its final return to include the income and related tax effect on this (would be at 35% instead of at 15% had the utility company not overcharged in each of those years), and should the stockholder's personal return for that year also be amended because the liquidating distribution should have distributed the receivable less the related tax liability that the corporation also should have recorded?

I'm really having a difficult tax season and now this is the icing that has my head spinning.   If anyone has dealt with something like this, I'd appreciate the advice on proper reporting.

[BulldogTom]

Off the top of my head, I am thinking that if the shareholder is the only one, then take it into income on his 1040.  I know it is not correct, but the corporation is defunct and cannot receive the payment (no checking account, no way to take the money in).  Give the utility a W9 with the shareholder's TIN and bring it in on the personal return.

Unless you want the headache and the extra income that goes with it.

Tom
Newark, CA

[DANRVAN]

Agree with Bulldog.

[jklcpa]

This is making me really nervous because this refund is $135K and because the final year of the corp is still an open year.  Also, the corporation did file its returns on the accrual basis.

Obviously the company didn't know about this at the time it liquidated, and I don't think the owner could have anticipated or calculated the receivable. The attorney told me it was the electric company that discovered the problem early this month, was caused by a faulty meter, and that they calculated the overcharges going back about 10 years.  The owner said that looking back now he can see an increase, but at the time when he was busy with operations, each month's overage wasn't significant enough to question and thought it was due to increased usage and rate increases. 

Would you still handle this only at the personal level?

 

[Lee B]

First, I agreed with Tom. But now, if at all possible I would put this on the back burner until after tax season. This is going to require some serious research.

[DANRVAN]

At $135,000 I would take a hard look at. I see two issues, first would the corporation need to file amended returns if the tax is paid at the corp level.  Secondly if the shareholders claim the refund is there an assignment of income issue.

I believe you are off the hook on the first issue.  Per  Reg 1.446-1(c)(ii)  "under an accrual method, income is to be included for the taxable year when all the events have occurred that fix the right to receive the income and the amount of the income can be determined with reasonable accuracy". 

The second issue opens a can of worms tried by case law where reference is given to Reg § 1.6012-2 Corporations required to make returns of income; which states  "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 purpose 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 in existence."

There are a number of cases you can look at.  "SIGURD N. HERSLOFF, 46 TC 545". In this case, it was determined that an asset award due to a dissolved corp. was not taxable to the corp. but to the surviving share holders. The opinion reads:

"Considering anew the issue in this case, we are of the opinion that since both dissolved corporations had ceased business, were without assets, were not being operated by the newly appointed trustees, the dissolved corporations must be regarded as fully liquidated and no longer in existence for tax purposes. Accordingly, we hold that the Commissioner erred as was alleged by petitioners in their assignment of error previously set forth herein."

Here are a couple more cases you might look at:

Beauty Acquisition Corp. v. Commissioner, TC Memo 1995-87 is a  case where the IRS failed to prove  "the corporation has valuable claims for which it will bring suit during this period". Therefore  the income was not taxable to the corp.

JAMES PORO, 39 TC 641  where a lawsuit asserting a claim of the corporation was started several years after distribution of all corporate assets and was filed in the name of trustees in dissolution of the corporation, the Tax Court held that the claim was asserted on behalf of the shareholders, rather than the corporation. Thus, the corporation was not subject to tax on the collection of the claim

I think you have a strong case in favor of reporting the refund to the shareholder.  I would discuss the regs and case law with him, and document that discussion. One thing that is certain is the corp. did not bring suit against any valuable claim per Reg § 1.6012-2.

[jklcpa]

Dan, thank you so much. I will take time to read each of those cases soon.

One other thing that's bothering me now after reading what you wrote about those cases is that the attorney advised the stockholder that it was not necessary to go through with a formal dissolution, to simply not pay the franchise tax to the Sec of State and let the corporation's certificate be not in good standing.  I may need to check with the attorney on this, but if I recall, I think he told the stockholder that the corporation is considered out of existence after several years of not being in good standing, might have been 3 years.  I have never liked that advice and told my client that at the time.

 

[BulldogTom]

3 hours ago, jklcpa said:

Dan, thank you so much. I will take time to read each of those cases soon.

One other thing that's bothering me now after reading what you wrote about those cases is that the attorney advised the stockholder that it was not necessary to go through with a formal dissolution, to simply not pay the franchise tax to the Sec of State and let the corporation's certificate be not in good standing.  I may need to check with the attorney on this, but if I recall, I think he told the stockholder that the corporation is considered out of existence after several years of not being in good standing, might have been 3 years.  I have never liked that advice and told my client that at the time.

 

That changes things.  I was under the assumption that the closing of the corporation was done with the filing of all required forms with the SOS and final tax filings.  If that corp is not dissolved by the SOS, then I think you need to file a return for it.  If the corp has been dissolved by the SOS, then I stand by my original position.

Tom
Newark, CA

[DANRVAN]

1 hour ago, BulldogTom said:

That changes things.  I was under the assumption that the closing of the corporation was done with the filing of all required forms with the SOS and final tax filings.  If that corp is not dissolved by the SOS, then I think you need to file a return for it.  If the corp has been dissolved by the SOS, then I stand by my original position.

The IRS and the courts could care less about state law. Note what  Reg § 1.6012-2 posted above says  "whether or not under State law it may thereafter be treated as continuing as a corporation"

Also, Rev. Rul. 54-518, 1954-2 CB 142 states "There is no provision insection 112(b)(7) of the Code, and the regulations promulgated thereunder, which requires the formal or legal dissolution of a corporation. However, for the purpose of this section, where, as in the instant case, a corporation ceases business operations, has retained no assets, has no income, and has actually liquidated within the calendar month, there is in effect a de facto dissolution even though the corporation has not been formally dissolved. See I. T. 3871, C. B. 1947-2, 62; Rev. Rul. 215, C. B. 1953-2, 149; A B C Brewing Corporation v. Commissioner, 20 T. C. 515"

Also note what the IRM states:

4.11.7.4  (12-01-2004)
Definition of "Complete Liquidation"

 

1. "Complete liquidation" is a term not defined by the Code. The regulations under IRC section 332 suggest that the status of liquidation exists when the corporation ceases to be a going concern and its activities are merely for the purpose of winding up its affairs, paying its debts, and distributing any remaining balance to its shareholders. The Tax Court applies a three-pronged test to determine whether a complete liquidation has taken place (see Joseph Olmstead v. Commissioner T.C. Memo 1984-381):

   • Was there a manifest intent to liquidate?

   • Was there a continuing purpose to terminate corporate affairs and dissolve?

   • Were the corporate activities directed and confined to that purpose?

    

2. Dissolution under state law or lack thereof will not be controlling for federal tax purposes. Intent coupled with actual distributions to the shareholders are the usual determining elements.

3. IRC section 346(a) allows for a series of distributions pursuant to a plan of liquidation to be treated as being part of a complete liquidation. If the plan is not formal or is ambiguous, there may be uncertainty as to which distributions are made pursuant to the plan. Distributions made before there is evidence to support an intention to liquidate should be taxable as dividends (ordinary income to a shareholder).

4. The U.S. Tax Court's decision in Pittsburgh Realty Investment Trust v. Commissioner, 67 T.C. 260, 1976, shed some light on a corporate liquidation. The Court stated that:

   1. 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.

   2. 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.

 

 

 

[BulldogTom]

Danrvan, I agree with you on the Federal side.  What about the state?  Where I live, the state don't give a rat's @$$ what the feds think either.  I think the state would want a tax return.  They have their own revenue and taxation code with their own court cases.  You could be sandwiched between two tax authorities.

Without a formal dissolution of the corporation, I think the water could get very muddy if you took it into the personal return of the taxpayer.  Another factor is how long it has been since the corp stopped operating and went de facto defunct. 

I think it would be cleaner, depending on how long it has been since the de facto dissolution to file the Fed and State returns than it would be to try to explain it later at audit.

Just my 2 cents.

Tom
Newark, CA

[DANRVAN]

14 hours ago, BulldogTom said:

Danrvan, I agree with you on the Federal side.  What about the state?  Where I live, the state don't give a rat's @$$ what the feds think either.  I think the state would want a tax return.  They have their own revenue and taxation code with their own court cases.  You could be sandwiched between two tax authorities.

I don't see a concern with state of California. We get transplants here so I am aware of California Conformity to fed tax code and adjustments for differences. I am not aware of any adjustment for difference in recognizing dissolution of corporation.

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California Conformity to Federal Law

On September 30, 2015, AB 154, the Conformity Act of 2015 was enacted. The Act changes California’s conformity date to the Internal Revenue Code from January 1, 2009, to January 1, 2015. California’s conformity results in numerous substantive changes to both personal and corporation tax law with respect to those areas of preexisting conformity that are subject to changes under federal laws enacted after January 1, 2009. However, there are continuing differences between California and federal law. When California conforms to federal tax law changes, we do not always adopt all of the changes made at the federal level. For more information, get FTB Publication 1001, Supplemental Guidelines to California Adjustments.