Did a Section 332 liquidation create former Texas earned surplus or receipts for the parent or subsidiary?

Plain-English summary

A qualifying tax-free subsidiary liquidation created no former Texas earned surplus or receipts for either corporation.

The parent owned all of a subsidiary that held interests in entities owning appreciated Texas real estate. The subsidiary planned to liquidate into the parent under Sections 332 and 337(a), with no federal gain recognized and carryover basis preserving the deferred gain.

Texas said the parent should not include the deferred gain in earned-surplus receipts or taxable earned surplus because the gain was neither federal taxable income nor federal revenue. The subsidiary likewise included no amount because it recognized no federal taxable income.

What this means for you

Corporate groups reviewing historical liquidations

The former earned-surplus result followed the federal nonrecognition treatment described in the letter.

Tax professionals

First establish that the transaction actually qualified under Sections 332 and 337(a); the Texas answer was expressly based on that treatment.

Common questions

Q: Did the parent include the deferred gain?
A: No.

Q: Did the subsidiary report earned surplus or receipts from the transfer?
A: No.

Q: Was the gain permanently eliminated?
A: The letter described it as deferred through the parent's carryover basis, not eliminated.

Citations and references

• I.R.C. Secs. 332 and 337(a)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/9707675L

Original ruling text

July 10, 1997

Dear **:

In your letter of June 27, you requested a determination regarding the
computation of earned surplus when a subsidiary corporation is liquidated into
its parent corporation.

You state that the parent corporation (Parent) owns 100% of the stock of a
subsidiary (Subsidiary) which does business in Texas. Both corporations are
formed under the laws of New York. Subsidiary owns interests in limited
liability companies, partnerships, and corporations that own Texas real estate
which has appreciated in value. Subsidiary will liquidate and transfer its
assets to Parent in a transaction described in Internal Revenue Code (IRC)
Sections 332 and 337(a). Under these sections, the transfer of assets from a
subsidiary corporation to a parent corporation pursuant to a plan of
liquidation of the subsidiary corporation will be tax free for federal income
tax purposes. Accordingly, the transfer by Subsidiary to Parent will not
result in taxable income for federal income tax purposes.

I understand that IRC Sec. 332 provides that where the stock of a liquidating
corporation is held by another corporation under a parent-subsidiary
relationship any gain or loss on liquidation is deferred until eventual
disposition of the assets by the parent corporation. This is accomplished by
providing that the basis of assets received by the parent on the liquidation is
generally the same as the basis to the subsidiary.

Based on my understanding of IRC Sec. 332:

Parent should not include the deferred gain in computing receipts or taxable
earned surplus for earned surplus. Specifically, the deferred gain is not
included in federal taxable income and is not a revenue for federal income tax
purposes.

Subsidiary will not include any amounts in receipts or taxable earned surplus
for the earned surplus component because no taxable income is recognized by
Subsidiary for federal income tax purposes.

This response is based on the facts presented and current law. If there are
different or additional facts, the response may change.

If you have any questions, contact Tax Policy Division. You may call toll free
1-800-531-5441, or our regular number is 512/463-4600. My extension is 3-4662.
You may write me at Tax Policy Division, Comptroller of Public Accounts.

Sincerely,

Bob Jeffcoat
Tax Policy Division