Form 966 Dissolution Code Section: 331, 332, or 337

On Line 10 of Form 966, Section 331 is the default for a standard taxable liquidation, and Section 332 applies only when a parent corporation that owns at least 80 percent of a subsidiary’s voting power and value is liquidating that subsidiary. The choice between Section 331 and Section 332 on Form 966 determines who recognizes gain, whether the transaction is taxable at all, and how the corporation and its shareholders must report the liquidation on their returns. Picking the wrong section creates mismatched reporting between the corporation, its shareholders, and the IRS.

What Line 10 Is Actually Asking

Line 10 on Form 966 asks you to identify the Internal Revenue Code section under which the liquidation will be treated.¹ For nearly every corporate liquidation, the answer is either Section 331 or Section 332. The form is short, but this single field tells the IRS how to expect the rest of the reporting to line up: a Section 331 filing signals corporate-level gain on the final Form 1120 and capital gain or loss reporting by shareholders, while a Section 332 filing signals a tax-free parent-subsidiary transaction.

You cannot pick the section you prefer. The facts determine which one applies. If the 80-percent ownership requirements for Section 332 are met, Section 332 governs whether the parent likes it or not; if they are not met, Section 331 is the only option.

Section 331: The Standard Taxable Liquidation

Section 331 applies to most corporate liquidations, and it produces tax at two levels.

Shareholders treat the liquidating distribution as full payment in exchange for their stock.² Each shareholder compares the fair market value of what they received against their adjusted basis in the stock, and the difference is a capital gain or loss. If the stock was held more than a year, long-term capital gain rates apply.

At the same time, the corporation recognizes gain or loss under Section 336 on every piece of property distributed, as if it had sold each asset at fair market value.³ Say a C corporation distributes an asset with a $100,000 basis and a $300,000 fair market value. It recognizes $200,000 of gain on its final Form 1120. Then the shareholders who receive that property compute their own gain against their stock basis. The same appreciation gets taxed twice, once at the corporate level and once at the shareholder level. That is the classic cost of operating and winding down through a C corporation, and it is what Line 10 telegraphs to the IRS when you write “Section 331.”

Section 332: The Tax-Free Subsidiary Liquidation

Section 332 produces a very different result, but it is available in only one specific structure: a parent corporation liquidating a subsidiary it controls.

The parent must own at least 80 percent of both the total voting power and the total value of the subsidiary’s stock.⁴ The 80-percent test comes from Section 1504(a)(2), and the parent must meet it on the date the plan is adopted and continuously through the completion of the liquidation.⁵ Miss the threshold on either measure, or fail to hold it throughout, and Section 332 is off the table.

When Section 332 does apply, the parent recognizes no gain or loss on the property it receives from the subsidiary.⁴ Instead of stepping the assets up to fair market value, the parent takes a carryover basis, meaning the built-in gain follows the assets and surfaces later if the parent sells them. This is deferral, not forgiveness, and that difference is the whole point of the section: corporate groups can reorganize without triggering an immediate tax hit.

Section 337: The Subsidiary’s Matching Nonrecognition

Section 332 handles the parent’s side. Section 337 handles the subsidiary’s side. When the parent meets the 80-percent test, the liquidating subsidiary also recognizes no gain or loss on the distributions it makes to that parent.⁶ The two sections work as a pair, which is what makes the transaction fully tax-free at the corporate level.

One important limit: Section 337 nonrecognition does not apply when the 80-percent parent is a tax-exempt organization, unless the distributed property will be used in an activity that generates unrelated business taxable income.⁶ A tax-exempt parent otherwise triggers gain recognition at the subsidiary level even though the ownership test is met.

Choosing Between the Two

Work through the ownership facts first. If a single corporate parent owns 80 percent or more of both the voting power and the value of the liquidating entity, and it has held that stake continuously from the plan adoption date, Section 332 applies. If any of those pieces is missing, Section 331 applies:

The shareholders are individuals, trusts, partnerships, or a mix.
The largest corporate shareholder owns less than 80 percent.
The parent’s ownership crosses the 80-percent line only after the plan is adopted, or drops below it before the liquidation completes.
The liquidating entity is an S corporation being wound down by its individual shareholders.

The label on Line 10 has to match the substance. Writing “Section 332” on a filing where the parent owns only 70 percent does not make the transaction tax-free; it just guarantees a discrepancy when the returns are examined.

How Liabilities Affect the Numbers You Report

Whichever section applies, if you are reporting fair market values, watch how liabilities interact with them. Under Section 336, when distributed property is subject to a liability, or a shareholder assumes a corporate liability in connection with the distribution, the fair market value of that property is treated as no less than the liability amount.³ Distribute a building worth $400,000 that carries a $500,000 mortgage, and the IRS treats the fair market value as $500,000 for gain or loss purposes. That floor can turn a break-even distribution into a taxable gain.

If the Plan Changes After You File

Ownership can shift, structures can be restructured, and the section you cited on the original Form 966 may no longer describe what actually happened. If the corporation amends or supplements its resolution after filing, it must file an additional Form 966 within 30 days of the amendment. Enter the date the earlier Form 966 was filed on Line 11 and attach a certified copy of the amendment.¹ The follow-up filing only needs to include information not already on the original.

If a Section 332 plan falls apart because ownership drops below 80 percent partway through, the liquidation converts to a Section 331 transaction by operation of law, and the reporting needs to catch up accordingly. Correcting the Line 10 answer on an amended Form 966 keeps the paper trail consistent with what the final Form 1120 and any shareholder 1099-DIV reporting will show.

Who Doesn’t Use Either Section

Two situations sit outside this Line 10 question entirely. Exempt organizations such as 501(c)(3) nonprofits do not file Form 966 at all; they follow the dissolution procedures in the instructions for Form 990 or Form 990-PF. Qualified Subchapter S subsidiaries also do not file Form 966.¹ The QSub exclusion is narrow, though: it covers only a subsidiary that has actually elected QSub status under Section 1361(b)(3). A regular S corporation being wound down does file Form 966, and its Line 10 answer is almost always Section 331.

1
Internal Revenue Service. Form 966 Corporate Dissolution or Liquidation
2
Office of the Law Revision Counsel. 26 USC 331 – Gain or Loss to Shareholder in Corporate Liquidations
3
Office of the Law Revision Counsel. 26 USC 336 – Gain or Loss Recognized on Property Distributed in Complete Liquidation
4
Office of the Law Revision Counsel. 26 USC 332 – Complete Liquidations of Subsidiaries
5
Office of the Law Revision Counsel. 26 USC 1504 – Definitions
6
Office of the Law Revision Counsel. 26 USC 337 – Nonrecognition for Property Distributed to Parent in Complete Liquidation of Subsidiary