Rev. Rul. 78-285

ISSUE

Will the sale by a shareholder of shares of stock in a corporation prior to the adoption of a plan of liquidation enable the shareholder to reduce stock ownership in the corporation to the extent that the 20-percent stock ownership limitation of section 341(e)(4) of the Internal Revenue Code of 1954 is not exceeded?

FACTS

Corporation Y owned 21 shares (21 percent) of the 100 shares of outstanding stock (common) of corporation X. The balance of the X stock was owned by several unrelated individuals, none of whom owned more than 19 shares. On March 1, 1977, Y unconditionally sold 3 shares of its X stock to a buyer who was unrelated to any of the shareholders. This sale reduced Y's percentage of stock interest in X to 18 percent. On March 6, 1977, the shareholders of X adopted a plan of complete liquidation. X then sold all of its assets to Y and distributed the net proceeds of the sale to its shareholders prior to March 6, 1978 and dissolved. The X assets sold to Y were assets subject to an allowance for depreciation in the hands of X. X met the definition of a collapsible corporation within the meaning of section 341(b) of the Code. Y recognized ordinary income on the sale of the 3 shares in accordance with section 341(a) of the Code.

LAW AND ANALYSIS

For law restricting a collapsible corporation from nonrecognition of gain or loss upon sale of its assets in connection with its liquidation, see section 337(c)(1)(A) of the Code.

For law relieving a corporation from collapsible status for purposes of section 337 application under certain conditions, see section 341(e)(4) of the Code.

Section 1.341-6(g)(2) of the Income Tax Regulations provides that an otherwise collapsible corporation will not be extended relief from collapsible status under section 341(e)(4) of the Code and gain or loss will be recognized to the liquidating corporation on the sale or exchange of property if the sale or exchange is made to any actual or constructive shareholder who is considered to own more than 20 percent in value of the outstanding stock of the corporation if such property in the hands of the corporation or in the hands of such shareholder is property in respect of which a deduction for exhaustion, wear and tear, obsolescence, amortization, or depletion is allowable.

Since the sale of X stock by Y occurred on a date before the date of adoption of the plan of complete liquidation by the X shareholders, the concept of an anticipatory sale by Y of liquidation proceeds is not applicable. See Allen v. Commissioner, 66 T.C. 340 (1976), and Jones v. United States, 531 F.2d 1343 (6th Cir. 1976), which held that the donation of corporate stock by a shareholder after the adoption of a plan of complete liquidation was an anticipatory assignment of the liquidation assignment of the liquidation proceeds.

Moreover, the unconditional sale of X stock by Y to an unrelated buyer is accorded independent significance since it was neither transitory nor illusory and was in no way conditioned upon the subsequent liquidation of X. In Granite Trust Co. v. United States, 238 F.2d 670 (1st Cir. 1956), the taxpayer, contemplating the complete liquidation of its wholly owned subsidiary at a loss, transferred 20.5 percent of the common stock to third parties. The taxpayer thus became less than an 80-percent shareholder, so that the nonrecognition of gain or loss provisions of section 112(b)(6) of the Internal Revenue Code of 1939 (predecessor of section 332 of the 1954 Code) would not apply to the liquidation of the subsidiary. A plan of complete liquidation was then formally adopted, after which the taxpayer sold some of its stock in the subsidiary. The United States Court of Appeals for the 1st Circuit, while recognizing that the transfers of stock were motivated solely by tax considerations, held that section 112(b)(6) of the 1939 Code did not apply, and that the taxpayer's loss on liquidation of the subsidiary was recognizable.

HOLDINGS

The sale of X stock by Y on March 1, 1977, enabled Y to reduce its stock ownership in X to the extent that the 20-percent stock ownership limitation of section 341(e)(4) of the Code was not exceeded. Thus, provided the other requirements of section 341(e)(4) are met, the sale by X of assets to Y within the 12-month period beginning on March 6, 1977, the date of adoption of a plan of complete liquidation by the shareholders of X, qualifies for nonrecognition treatment under section 337(a).