Chip and Dale are each 50% owners of Tree Corporation, a holding company. They have each held their stock since the company was formed five years ago. Tree's money is invested almost entirely in stocks, bonds, rental real estate, and land. All of the stocks are traded on the New York Stock Exchange except for 1,000 shares of Conifer Corporation stock. Conifer is privately held by 50 individuals.
Last year, Conifer reported about $2 million in net income. During a meeting with Chip and Dale, you discover that they plan to liquidate Tree Corporation as soon as possible to avoid the personal holding company tax. What tax issues should Chip and Dale consider with respect to this liquidation?
What will be an ideal response?
Chip and Dale should consider the following tax issues:
• Can the personal holding company tax be avoided by changing the investment/operating decisions of Tree Corporation?
• What gain or loss does Tree Corporation recognize if a liquidation occurs?
• What gains or losses do Chip and Dale recognize if Tree Corporation is liquidated?
• Is it possible for the open transaction doctrine to apply to the liquidation of Tree Corporation due to an inability to value the Conifer stock?
• Can the personal holding company tax be avoided by having Tree Corporation make an S election?
• What tax increase will occur if Chip and Dale personally own the property currently held by Tree Corporation?
Tree Corporation should determine whether the personal holding company (PHC) tax could be avoided by increasing the portion of Tree's income earned from rental real estate activities to permit the rental income to be excluded from the personal holding company income (PHCI). This technique may require that Tree shift asset composition from stocks and bonds to real estate.
If a liquidation occurs, an appraisal of the Conifer stock will be needed. The IRS is unlikely to permit the open transaction doctrine to apply to the Tree Corporation liquidation merely because market quotations for Conifer stock are lacking.
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