Question

Indigo corporation has a basis of $1 million in the stock of Owl Corporation, a subsidiary in which it owns 100% of all classes of stock. Indigo purchased the stock in Owl 10 years ago. In the current year, Indigo liquidates Owl and acquires assets worth $1.2 million. At the time of its liquidation, Owl Corporation had a basis of $800,000 in the assets and E&P of $500,000. Which of the following statements is correct with respect to the liquidation?

a. Owl recognizes a gain of $400,000.
b. Indigo has an $800,000 basis in the assets.
c. Owl's E&P of $500,000 is eliminate
d. indigo recognizes gain of S200,000.
e. None of these

Answer 1

The correct option is (d) Indigo recognizes a gain of $200,000. Owl recognizes a gain of $400,000 and Owl's E&P of $500,000 is not eliminated.

Step-by-step explanation:

The correct option for the asked question is (d) Indigo recognizes a gain of $200,000.

When Indigo liquidates Owl Corporation, the subsidiary's basis of $800,000 in assets is stepped up to the fair market value of $1.2 million. As a result, Owl recognizes a gain of $400,000 ($1.2 million - $800,000).

Indigo, as the parent company, recognizes a gain of $200,000 ($1.2 million - $1 million basis in the stock).

Owl's E&P of $500,000 is not eliminated in this liquidation process.

Liquidation in a subsidiary corporation refers to the process of winding down and closing the subsidiary's operations. This occurs when the parent company decides to cease the subsidiary's business activities, often due to strategic reasons, financial distress, or restructuring. During liquidation, assets are sold, debts settled, and any remaining funds distributed to shareholders. It involves legal procedures to ensure compliance with regulations. The subsidiary may dissolve entirely or be merged into another entity. Liquidation decisions are typically made by the parent company's management, and the process aims to maximize returns for stakeholders while fulfilling legal obligations.