Liquidating Trust

[Linda Mathey]

I have never dealt with anything like this before and hope someone can point me in the right direction.

A client of mine owns 97.4% of a C Corporation which sells oils, lubricants, etc. The Corporation is selling it's assets, inventory, A/R etc. In addition, the purchaser will pay the seller for retained gallons (which refers to customers they retain and the total gallons those customers purchase during 2009.)

The purchaser will pay the seller at closing for the assets, inventory and A/R so the seller can pay off all debts. If this amount is not sufficient, the purchaser has agreed to advance the seller enough money against future payments for retained gallons to cover all debt. The remaining part of the purchase price will be paid over the next four quarters and will be based on historical sales to these customers. After 390 days they will "true" up the payments based on actual sales and either the seller will owe them money or they will owe the seller money.

In order to allow the corporation to liquidate by 12-31-08, the attorney will set up a liquidating trust and the shareholders will assign their shares to the trust. The trust will then transfer the shares back to the corporation in exchange for the right to receive the post-closing payments. By doing this, the corporation can dissolve before the end of 2008 since it will have neither shareholders nor assets. In addition, all of the rights to receive the post-closing payments will then be assigned to the two shareholders in proportion to the shares they currently own in the selling corporation.The trust will then have the right to receive the four quarterly payments and the final "true up" amount. In addition any A/R that are rejected by the purchaser will be distributed to the trust and attempts made to collect them.

My questions are:

1. Do I report the assignment of post-closing payments on the corporation's final tax return? If yes, how do I assign a value since that will not be determined until the end of 2009?

2. What about the shareholder's basis and paid in capital in the corporation?

3. Is the assignment of their shares to the trust considered a sale of their stock to the trust? If yes since proceeds cannot be determined until the end of 2009, how and when do I report this sale of stock?

4. Is there anything else I need to be concerned about?

[kcjenkins]

((3)Liquidating Trusts, Voting Trusts, and Similar Entities

In addition to investment trusts, the regulations give specific sanction to another category of trusts motivated by commercial reasons, rather than reasons of personal or estate planning. Reg. Section 301.7701-4(d) protects from "association" classification those trusts formed for the purpose of winding up a corporation's affairs subsequent to a liquidation, and to "bondholders' protective committees, voting trusts or other agencies formed to protect the interests of security holders during insolvency, bankruptcy, or corporate reorganization proceedings."

The rationale for granting trust status to liquidating trusts is that their objective is a limited one, not directed to the carrying on of business by an entity. The liquidation must also be of limited duration. If it is unreasonably extended, the status of the trust may be placed in jeopardy. Thus, according to Reg. Section 301.7701-4(d), "If the liquidation is unreasonably prolonged or if the liquidation purpose becomes so obscured by business activities that the declared purpose can be said to be lost or abandoned, the status of the organization will no longer be that of a liquidating trust."

As a disincentive to this kind of behavior, the IRS has issued advance ruling guidelines that generally limit the term of a liquidating trust to three years, limit investments to short-term instruments (Rev. Proc. 82-58 Section 4.04, 1982-2 C.B. 847), and set forth related restrictions on the scope of the trust's activities. Although the ruling guidelines do not purport to represent the limits of a liquidating trust's activities as a matter of substantive law (Rev. Proc. 82-58 Section 2, 1982-2 C.B. 847) and older judicial decisions have upheld the status of liquidating trusts exceeding the IRS's guidelines, the ruling guidelines serve as a warning to taxpayers seeking to employ liquidating trusts as a means of escape from the 1986 Act's relatively high corporate rates. To similar in terrorem effect, the regulations warn that the pass-through characterization of voting trusts, bankruptcy trusts, and similar entities will be lost if the trusts are "utilized to further the control or profitable operation of a going business on a permanent continuing basis."

[Linda Mathey]

Thanks KC for the cites. I will review them.

Do you or anyone else have insight as to how to handle the compliance issues?

Right now my thoughts are:

1. If they transfer their stock to the liquidating trust prior to 12-31 I will have to prepare both a final 1120 and an initial 1041.

2. If the transfer of their stock to the trust triggers a sale that must be reported in 2008 and since they will receive no cash in 2008, it would be a capital loss. Then in 2009 when the trust receives and distributes the four quarterly payments for the "retained gallons" that would be a capital gain with no basis and would be offset by the carryforward loss.

3. Any receivables that the purchaser refuses because they are older than 60 days will be distributed to the trust along with the right to receive the post closing payments. Am I correct in thinking that since the corporation already recognized the income from these sales, any collections received by the trust would be part of the capital gain since the A/R were received as part of the exchange for the shareholders stock? However, if the A/R prove to be uncollectible wouldn't that generate an ordinary loss?

4. Any ideas as to whether the corporation would have to report for tax purposes the receipt of all its shares in exchange for post closing payments and any refused A/R when the dollar amounts are yet to be determined?

Sorry if it sounds like I am confused but I am. I may be getting so wrapped up in the "how to's" that I can't see the forest for the trees.