Definition
A collapsible corporation is a term used under U.S. tax law to describe a corporation that is dissolved before realizing a substantial portion of the taxable income expected to be derived from its assets. This practice often aims to convert what would ordinarily be capital gains into ordinary income to the stockholders, thus avoiding higher capital gains taxes. According to the Internal Revenue Service (IRS), gains from the sale or liquidation of a collapsible corporation are treated as ordinary income, rather than capital gains, to the stockholders. This is done to mitigate tax avoidance tactics.
Examples
Example 1: Real Estate Development
A real estate development company sets up a subsidiary corporation to handle a specific project. The subsidiary finishes the project and is dissolved before realizing significant rental income, with the intention to distribute the assets to the parent company. The IRS might classify the gain from this transaction as ordinary income.
Example 2: Technology Start-Up
A technology start-up incorporates a subsidiary to manage the development of a new product. The subsidiary is dissolved shortly after the product is launched but before substantial revenue is generated. This dissolution is done to distribute the assets to the main company and shareholders. The IRS would treat this gain as ordinary income.
Example 3: Manufacturing Company
A manufacturing company forms a separate corporation to develop and test a new product. Before the product enters the market and earns significant income, the subsidiary is dissolved, and its assets are distributed to the shareholders of the parent corporation. The IRS will treat the gain from this distribution as ordinary income.
Frequently Asked Questions (FAQs)
What is a collapsible corporation?
A collapsible corporation is a corporation that dissolves before realizing substantial taxable income from its property, leading the IRS to treat the gain from its sale or liquidation as ordinary income.
Why is the gain from a collapsible corporation treated as ordinary income by the IRS?
The IRS treats the gain as ordinary income to prevent tax avoidance strategies that could exploit the capital gains tax rates, which are often lower than the rates for ordinary income.
How does a collapsible corporation impact tax liabilities for shareholders?
Shareholders might face higher tax liabilities since the gain is treated as ordinary income, which is typically taxed at a higher rate than capital gains.
Are there specific IRS rules regarding collapsible corporations?
Yes, the IRS has specific guidelines under U.S. tax law to deal with collapsible corporations, aimed at ensuring gains are appropriately taxed as ordinary income rather than capital gains.
Can any corporation be considered a collapsible corporation?
Not every corporation dissolving before realizing substantial income is automatically considered collapsible; the IRS looks at the intent and circumstances under which the corporation was dissolved.
Related Terms
Ordinary Income
Income earned from providing services or the sale of goods, treated differently from capital gains for tax purposes.
Capital Gains
Profits from the sale of an asset held for more than a year, typically taxed at a lower rate than ordinary income.
Tax Avoidance
The legal use of the tax regime to one’s own advantage to reduce the amount of tax that is payable by means that are within the law.
Liquidation
The process of bringing a business to an end and distributing its assets to claimants, often subject to specific tax treatments.
Online References
- IRS Topic No. 404 – Dividends
- Investopedia - Collapsible Corporation
- Wikipedia - Corporate Liquidation
Suggested Books for Further Studies
- “Federal Income Taxation of Corporations and Shareholders” by Boris I. Bittker & James S. Eustice
- “Principles of Corporate Finance” by Richard A. Brealey, Stewart C. Myers, and Franklin Allen
- “Corporations - Examples & Explanations” by Alan R. Palmiter
Fundamentals of Collapsible Corporation: Business Law Basics Quiz
Thank you for exploring the intricacies of collapsible corporations and engaging with our challenging study material. Continue refining your understanding to excel in your financial and legal endeavors!
