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safezone safezone
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Parent Corporation, which operates an electric utility, created a 100%-owned corporation, Subsidiary that built and managed an office building. Assume the two corporations have filed separate tax returns for a number of years. The utility occupied two floors of the office building, and Subsidiary offered the other ten floors for lease. Only 25% of the total rental space was leased because of the high crime rate in the area surrounding the building. Rental income was insufficient to cover the mortgage payments, and Subsidiary filed for bankruptcy because of the poor prospects. Subsidiary's assets were taken over by the mortgage lender. Parent lost its entire $500,000 investment. At the time Subsidiary was liquidated, another $100,000 of debts remained unpaid for the general creditors, which included a $35,000 account payable to Parent. What tax issues should Parent and Subsidiary consider with respect to the bankruptcy and liquidation of Subsidiary?
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Prentice Hall's Federal Taxation 2014 Corporations, Partnerships, Estates & Trusts

Prentice Hall's Federal Taxation 2014 Corporations, Partnerships, Estates & Trusts


Edition: 27th
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The managements of Parent and Subsidiary should consider the following tax issues:

•   What gain or loss does Parent Corporation recognize on the transfer of its remaining property to the mortgage lender?
•   Does Subsidiary Corporation have to recognize cancellation of indebtedness income from not having repaid its debts?
•   Does Subsidiary Corporation have to file a corporate tax return for the portion of the final tax year that it is in existence? If so, what income and expenses are included in the return?
•   Can Subsidiary Corporation deduct the liquidation expenses on its final tax return?
•   What is the amount and character of the loss that Parent Corporation recognizes upon surrendering its Subsidiary stock? Upon not being repaid for the open account indebtedness?
•   What happens to Subsidiary Corporation's tax attributes?

Because Parent Corporation received nothing for its investment in Subsidiary Corporation, it can claim a worthless security loss for the $500,000 investment. This loss should be an ordinary loss under Sec. 165(g)(3). Subsidiary's $35,000 debt to Parent should be deductible as a bad debt under Sec. 166. Because corporations do not have a distinction between business and nonbusiness debts, Subsidiary can claim an ordinary loss deduction for the bad debt in its final tax return.
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