Is a gain recognized under IRC Section 336 on a liquidating distribution included in Texas taxable earned surplus, and how is it apportioned?

Plain-English summary

A corporation making a liquidating distribution asked whether a gain recognized under Internal Revenue Code Section 336 - reported on its federal Form 1120 - is included in Texas taxable earned surplus, and if so, how it is apportioned. The Comptroller answered yes, and explained the sourcing.

• The federal treatment. IRC Sec. 336 requires a liquidating corporation to recognize gain or loss on a distribution of property in complete liquidation as if the property were sold to the distributee at fair market value.
• It flows into earned surplus. Because Texas net taxable earned surplus begins with a corporation's reportable federal taxable income, any IRC 336 gain reported on the Form 1120 is included in earned surplus (Tax Code Sec. 171.110(a)(1)).
• Apportioned as a sale of the assets. Since the distribution is treated as a sale of the distributed assets for federal purposes, the gain is apportioned under the Chapter 171 rules that would otherwise apply to the sale of those assets. The shareholder receiving the property is treated as the purchaser.

Currency note: This is the pre-2008 franchise tax's earned-surplus computation, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008. Treat as historical.

What this means for you

Corporations winding down

A liquidating distribution was not tax-free for franchise-tax purposes: the IRC 336 gain that hit your federal return also landed in Texas earned surplus. And you sourced it as if you had sold each asset, with the receiving shareholder standing in as the buyer.

Accountants and tax professionals

Trace the IRC 336 gain from Form 1120 into Sec. 171.110(a)(1) earned surplus, then apply the ordinary Chapter 171 sourcing for the sale of the specific assets distributed (for example, tangible property by place of delivery), treating the shareholder as purchaser. This earned-surplus base is pre-margin-tax.

Common questions

Q: Is an IRC 336 liquidation gain taxable for Texas franchise tax?
A: Yes. It is included in earned surplus because earned surplus starts from reportable federal taxable income, which includes the IRC 336 gain.

Q: How is the liquidation gain apportioned?
A: As a sale of the distributed assets under the Chapter 171 rules that would apply to selling those assets, with the shareholder treated as the purchaser.

Citations and references

Statutes:

• Tex. Tax Code Sec. 171.110(a)(1) (earned surplus begins with reportable federal taxable income)
• IRC Section 336 (gain on distributions in complete liquidation)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200405664L

Original ruling text

May 19, 2004

To: **,

Dear **:

Thank you for your Tax Help inquiry concerning a liquidating distribution and
Texas franchise tax. You asked if a gain recognized under Internal Revenue
Code (IRC) Section 336 and reported on the federal Form 1120 is to be included
in taxable earned surplus and, if so, how it is to be apportioned.

IRC Sec. 336 requires that a gain or loss shall be recognized to a liquidating
corporation on the distribution of property in complete liquidation as if such
property were sold to the distributee at its fair market value.

Since the determination of net taxable earned surplus begins with a
corporation's reportable federal taxable income, any IRC Sec. 336 gain reported
on the corporation's Form 1120 to arrive at its federal taxable income is
included in the corporation's earned surplus. See Texas Tax Code Sec.
171.110(a)(1).

Since the distribution is treated as a sale of the distributed assets for
federal tax purposes, the gain is apportioned according to the rules that
otherwise apply to the sale of such assets under the Texas Tax Code, Chapter

171. The shareholder receiving the distribution of property is considered to
     be the purchaser of the property.

The statutory citation mentioned above is available via the Comptroller's
website at www.window.state.tx.us. From the home page, click on the link to
"Texas Taxes," then on the link to "Taxes and Fees - Franchise." Click on the
link for "Statutes."

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

Our goal is to provide you with prompt, professional service. Please take a
moment to complete our on-line survey at
http://aixtcp.cpa.state.tx.us/surveys/tpsurv/.

If you have questions about this, my Internet address is
[email protected], or you may call toll free at 1-800-531-5441,
extension 31374.

Sincerely,

Laurie Massengale
Tax Policy Division