Academic journal article Law and Contemporary Problems

Who's Afraid of the Big Bad Tax-Free Liquidating Distribution? Ideological Debates on Taxation and the Repeal of General Utilities

Academic journal article Law and Contemporary Problems

Who's Afraid of the Big Bad Tax-Free Liquidating Distribution? Ideological Debates on Taxation and the Repeal of General Utilities

Article excerpt



The General Utilities doctrine, named for the (1935) Supreme Court decision (1) allowing a corporation to distribute appreciated assets to shareholders without reporting a taxable gain, was once known as one of seven fundamental principles of American corporate taxation. (2) The doctrine's popularity reached its peak in 1954, when Congress formally incorporated it into the Internal Revenue Code. (3) Despite this esteemed position among tax-law doctrines, General Utilities was routinely criticized because, among other things, it allowed a situational (and arbitrary) reprieve from "double taxation" of corporate income. (4) Corporate income (5) is functionally taxed twice in the sense that the corporation owes tax on the profits earned by its operations and the shareholders owe individual income taxes on the leftover, after-tax profits the corporation distributes to shareholders. The General Utilities doctrine reflects a tension that has existed throughout tax law history--that is, whether double taxation of corporate income is good policy. (6)

Over the years, many scholars and tax experts have expressed the view that two-level taxation of certain corporate entities is appropriate, while businesses and their tax counsel have routinely lobbied for and devised ways around this now-enduring feature of corporate taxation. This tension between a true two-tax regime and an "integrated" system in which only shareholders are taxed was one of the issues at the heart of the debate surrounding repeal of General Utilities. (7) Proponents of separating corporate and shareholder income see General Utilities as arbitrary and unreasonably advantageous for corporations. Those who believe that the fictional corporate person should not be taxable view General Utilities as a framework to integrate corporate income. General Utilities, then, was a blessing to tax attorneys and a predicament for the tax collector.

Both Congress and the Court attempted to balance this longstanding tension by formulating, reformulating, and grafting complex exceptions onto the doctrine. (8) As the doctrine got more complicated, many in the academy became convinced that General Utilities was a purely dogmatic convention with no logical justification. (9) However, those who believed that corporate double taxation was not sound policy in every respect saw General Utilities as far from unfairly advantageous for corporations. (10) There is no explanation in the General Utilities case, the Treasury regulations that might be considered the doctrine's origin, or any subsequent act of the Court or Congress why a transaction that resembles a sale of an appreciated asset would not trigger tax liability for the realized appreciation. On the other hand, the shareholders, and not the corporation, were the taxpayers who were formally and literally selling the shares. And, moreover, dividends in kind were not traditionally considered taxable events for the corporation. (11) Nonetheless, by the mid-1980s, the clamor for reform or repeal of General Utilities had reached a fever pitch, and in 1986 Congress entombed the formerly glorious precept of American tax law, thus extending the principle of double taxation (12) and also simplifying the tax treatment of distributions of corporate assets.

It has been over twenty-five years since General Utilities met its end. At the time, its repeal was considered, for better or worse, a "sea change" in American tax law. (13) No longer could liquidating corporations (14) distribute assets to shareholders and transfer them tax free. In addition, managing tax liabilities on various types of assets became simpler: all were taxed. (15) In the intervening years, most who were originally in favor of the doctrine's repeal were likely untroubled by its absence. A smaller group of scholars and a few tax professionals, though, were not so sure. (16) Some of the ill effects supposedly vanquished by the doctrine's repeal were replaced with others. …

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