 Hello and welcome to this session. This is Professor Farhad and this session we're going to be looking at section 338 election, which is part of complete corporate liquidation or distribution. This topic is covered in a corporate income tax course as well as the CPA exam, the regulation section. As always please connect with me only then. YouTube is where you need to subscribe. I have over 1500 plus accounting, auditing and tax lectures. If you like my lectures, please like them, share them, put them in the playlist. If they're benefiting you, it means they might benefit someone else. So please share the wealth. This is my Instagram account, my Facebook account and I do have a website on my website. You can get in touch with me. You could also make a donation if you'd like to support the channel. So let's talk about the liquidation under 332 or the general rule. If you remember this is a review when there is a liquidation between the parent and the subsidiary, there is no tax consequences. So the liquidation of the subsidiary generally result in a non-taxable transaction and that means no recognition of gain or loss for both the parent and the subsidiary and the carryover of the subsidiary goes to the parent. The carryover basis goes to the parents. Now this is the general rule, a clean cut rule and you might be saying, okay, what's the point? Well, sometime it may not be in the best interest of the parties. We might be saying, hold on a second, I don't have to pay taxes. Well, there might be other considerations. So let's take a look at this example to start the point. On April 27, 2018, a corporation acquired 100% of the common stock of Amazon Corporation. Amazon had 750 EMP and they paid 1.2 million. Amazon Corporation has assets with a fair value of 1.4, a basis of 800,000 with no liabilities, no loss or tax credit. Let's stop right here. When we do this parent liquidation, parent subsidiary liquidation, what would happen is this, we pay 1.2 million for the assets that are worth 1.4 and the basis, the basis of the sub. So basically, this is the basis of 800,000. This is the sub and the basis of this asset goes to the parent company as 800,000. So okay, what's the problem here? Well, there is no problem really, but if you really think about it, we paid 1.2 million dollar. We paid 1.2 million dollar. This is the basis and this is the outside basis in the stock. So the outside basis in the stock is 1.2. The inside basis of the asset, the basis of the assets are 800,000. Okay? So what does that mean? It means we paid something 1.2 million. We paid for it 1.2 million and that's our stock basis. However, the basis of the asset that we brought to our books is 800,000. So the question becomes, is there a way, is there a way to have more basis in the assets that we bought because if we paid 1.2 million, why do we have a lower basis? So what's the problem? Well, kind of there's two issues that will benefit us if we could increase the basis. One is we have more depreciation. So if we can have the basis more than 800,000, it means if we can have the basis higher than 800,000, when we depreciate this asset, we'll have more depreciation. Two, when we sell this asset in the future, sell it in the future, if we have a higher basis, it means we have lower gain. So there are two benefits. If somehow, if somehow we can have more basis in the asset, but the rule is, well, you transfer the basis. Well, that's the rule. Then there is this section 338 rule. What is section 338? You may elect to treat the purchase of the stock as a purchase of the asset. So what you do, rather than saying I'm buying the stock of Amazon, you would say I am buying the asset of Amazon. So this is like kind of, it's beamed purchase. Basically what we're saying is it's as if we have purchase, treat as if we bought the assets. So we have to make this election by the fifth day of the nine month following the qualified purchase plan. So you have, so the company will have to decide on this by fifth day of the qualifying, by the 15th, not the 15th, the 15th day of the nine month following the qualified purchase. What is the qualified stock purchase? It starts when the corporation acquire at least 80% of the voting power and it has to be within 12 months. So there's a period of time where you have to make this election. So what does this election allow you to do? It will allow you to say you bought actually the assets, not the stocks. So what are the mechanics? First, the subsidiary may or may not be liquidated. So you don't have to liquidate the subsidiary when you bought it. And we're going to see what do I mean by this. The subsidiary is deemed, is assumed to have sold its asset for the amount determined with reference to the parent subs basis and the subsidiary stock adjusted for liability of subsidiaries. Huh? Okay. Well, let's explain this. Deemed means we assume a price. We assume that it was the assets are sold at a price. Now how do we assume that price? We'll determine that price. You don't have to worry about how we determine the price, but we determine the price by referencing the parent basis and the subsidiary stocks adjusted for liabilities. Simply put, as far as you're concerned, the price will be given to you. So we will assume that we bought the assets at a certain price. And that situation, the subsidiary, if we bought their asset, remember, this is, if we are saying we bought the asset, we did not, we did not merge. Well, because remember, when a liquidation, when a liquidation occur, liquidation means the parents, the subsidiaries are merging. There is no really change in substance. It's only change in form. Now you're saying you bought the asset. Buying the asset means you might have a gain or you might have a loss. I mean, I don't care about the loss, but if I have a gain, it means I have to pay taxes. Well, guess what? We're going to go with that. We're going to assume that we bought the asset and pay taxes on those, on that transaction. Because if we bought the asset and the fair market value is higher than the cost, well, we have a gain. We have to pay, and the subsidiary will have to pay the gain. You might be saying, so why would we do so? Why, why would we pay taxes if we could have had that merger without any tax consequences? Well, you're going to see, kind of, we mentioned why, because the parent now will have a higher basis. Higher basis means more deduction down the road. And when we sell this asset later, we will have a lower gain. Lower gain means less taxes down the road as well. So just bear in mind, the parent will have no tax consequences. Parent, no tax, no tax effect. So on the parent, there is no tax effect. The only thing is the subsidiary will have to pay taxes. So the subsidiary now, once we do it, once we elect section 338, it will be treated, and you will see how in a moment, as a new corporation. So once we buy our assets, it's going to be treated as a new corporation. Okay? The subsidiary is treated as a new corporation that purchase all its asset on the day after the qualified stock purchase date. So what we say is, think about it. It's like the subsidiary transferred into a new subsidiary by buying its own asset. That's, that's what really happened. So we have a new, we have a new subsidiary, although it's the same one. And you will see how it's, it's basically it's legal, it's, it's legal, it's, it's a legal form, the legal form will change. And the best way to illustrate this is to work an example. Let's go back to this example. And we look at it when we started. So A purchased Amazon for 1.2 million. Amazon has assets of 1.4 million with the basis of 800,000. Now we're going to treat this as a section 338 election. So we agree to have a section 338. A corporation, the parent corporation, files on a timely basis section 338 election. Assume that the aggregate deemed sale price and the adjusted gross up basis is 1,306,329. Huh? What does that mean? Well, this is where the price I told you not to worry about. It means we deemed that the price of those assets is that much. It means A purchased the asset of Amazon. So here we're changing the scenario. Although we bought their stock, but we can say for tax purposes, we bought the asset. So kind of we're switching our assumption. We bought the stock. What we paid is 1.2 million for their stock and we bought all their stocks. But from a tax perspective, we're treating the transaction as if we purchased their asset. And how much did we pay? 1,306,329. Yeah, don't ask me where the number came from. It's a reference to the basis of the sub company, which we don't go in. It's beyond the scope of your course. So the deemed price is that much. Now, let's ask the first questions. What are the tax consequences of section 338 to Amazon, which is the sub, and to A, which is the parent, the Amazon and the parent? So let's take a look. Well, Amazon is the sub. Amazon is the sub. Amazon sold or deemed sold. I'm going to use the word sold, but deemed sold. That means if we treat it as if it sold it, deemed sold the asset for 1,306,329. And they have adjusted basis in the asset of 800,000. So simply put, what happened is they have again a 506,329. 506,329 again. Well, guess what? They have to pay 21% based on the new tax rate on the gain. They have to pay in taxes 106,329. That's the tax consequences for the sub for Amazon. So this is Amazon. So we could have, we could have, Amazon did not have to pay any taxes, but they choose to have to pay the taxes. Okay, so this is the tax consequences. What are the tax consequences for A? Well, there is no really no tax consequences for Oak. What happened is they have a basis in this asset of 1,306,329. That's what happened. They have the basis in that asset of that much. Okay. Now, when did the holding period start for? Oh, the holding period start April 28, the following day. So remember, the holding period affect your long-term, short-term. So the holding period start the second day. If we did with the 332 election, the holding period would have been also transferred. Okay. And Oak don't have to pay any taxes. There is no taxes for Oak. No taxes. Okay. So the only party that has a tax consequences is the, is the, is the subsidiary. Okay. Is the subsidiary. Okay. So that's the first question. What are the tax consequences? Now, Oak would still have 1.2 million outside basis. So that's what happened. Now, assume B. Now, this is where we have to look at the mechanics a little bit further. Assume that Amazon is liquidated immediately following the 338 election. So after they said, we bought our own assets. So basically what Amazon did, Amazon, they bought their own asset. They bought their own asset by paying the taxes, by deemed, deemed to have purchased their own asset, deemed to have purchased their own asset. In other words, now this is the old company. This is old Amazon. Now, we have a new Amazon. So let me just, we have a new Amazon. Basically, it's a new company. That company has an asset, has an asset with the basis. Remember, it has an asset with the basis of 1,306,329. And they bought that asset. In a sense, they, in a sense, this new Amazon bought the asset from the old Amazon. Okay. Because new Amazon sold, the old Amazon sold it to new Amazon, then Oak bought the new Amazon. Okay. This is what happened. Assume that Amazon corporation is liquidated immediately following the 338. Again, here think about this. The new Amazon is liquidated. What are the tax consequences to Amazon corporation as well as Oak? Now, basically, now when we do this liquidation, we assume it's 332 liquidation. Now, under this, under this liquidation, there's no tax consequences for A, because there is no gain and no loss. It's an apparent asset liquidation. And A, I already told you the basis in the A is 1,306. And this is when the basis happened, because A bought the, bought the new company. Okay. And what happened is now new Amazon, when the, when the new company is created, EMP is zero. EMP is zero. Now, I forgot to mention something earlier. Why would also, why would we also do section 338? Because the old Amazon might have NOL, net operating loss or other attribute or other tax credit. What, what does that mean? It means, let's assume that we have sold the asset, although we have 106, 329 of taxes, we might have NOL that's going to reduce the taxes, we might have tax credit that's going to reduce the taxes. So that's another incentive, why we will go with 338. So the old company will be able to use the NOL and the tax credit to reduce the tax effect and you transfer the basis to the new company, to A company, to the parent company with higher basis. Higher basis will give the new company more depreciation and will give the new company less gain down the road. Okay. So I know this is kind of like, what do you mean we created a new company? Basically, the old company is gone and assumed to have bought their asset. Let's look at the rules again, just kind of show you what I mean by this. Subsidiary is treated as a new corporation that purchase all its asset on the day after the qualified stock purchase. It adds up Amazon bought the asset. Also, it's, so we're making kind of two assumptions. We said we sold it, we sold the asset that we bought it because we're part of the new company. Remember, because the new company bought us. Okay. But from a legal perspective, we assume that we have sold it to ourselves and we have the new basis, then we liquidate into section 332 and we transfer this asset. So hopefully, we know what section 338 is now. Basically, rather than buying the stocks, we have to find a way to make the assumption that we bought the asset, which is going to give us a higher basis. Higher basis will give us higher depreciation and lower gain. And maybe the old company could also use their tax attribute to reduce their taxes when they actually, when they say they deemed to have sold the asset. If you have any questions about this topic, please email me. 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