Corporate Liquidation: The Tax Implications

When a corporation is liquidated, the transaction is subject to double taxation. This means that both the corporation and shareholders must generally recognize a gain or loss. The corporation usually deducts its liquidation expenses, such as professional and filing fees, on its final tax return. Generally, a corporate liquidation can take one of two forms. The corporation either sells off the assets and distributes the cash to the shareholders or distributes the assets directly to the shareholders. Either of these methods of liquidation result in tax implications at both the corporate and shareholder-level that are important for any taxpayer to understand.

Corporation Sells Assets and Distributes Cash to Shareholders

Under this scenario, the corporation makes a direct sale of its assets. This can potentially lead to a large taxable gain if the corporation’s assets are highly appreciated. At the corporate level, the taxable gain or loss is the sale proceeds minus the adjusted basis of the assets. Once the corporation distributes the remaining cash to the shareholders, there is a taxable gain or loss applied at the shareholder-level. When the shareholder receives the liquidating distribution from the corporation, this event is treated as a sale of the shareholder’s stock in exchange for cash. The taxable gain or loss to the shareholder is calculated by taking the liquidating distribution amount minus the shareholder’s basis in their stock. If the stock has been held for over a year, any shareholder gain will generally qualify for long-term capital gain treatment.

Corporation Distributes Assets Directly to Shareholders

If the corporation distributes the assets directly to the shareholders, the corporation will recognize a taxable gain or loss as if it sold the assets to the shareholders at fair market value. The taxable gain or loss is calculated by taking the fair market value of the assets distributed minus the adjusted basis. The shareholders will then recognize a taxable gain or loss to the extent that the fair market value of the assets received exceeds the adjusted basis of their stock.

Section 1244 Stock

Section 1244 of the tax code allows losses from the sale of shares of small, domestic corporations to be deducted as ordinary losses instead of capital losses up to $50,000 for single filers and $100,000 for joint returns. Any losses in excess of these amounts would be treated as a capital loss, which would first offset any capital gains, and then a maximum of $3,000 of capital losses per year would be deductible.

To qualify for Section 1244 treatment, the corporation, the stock, and the shareholders must meet many requirements. The main requirements include the following:

• The stock must be issued by U.S. corporations.
• The corporation’s aggregate capital must not have exceeded $1,000,000 when the stock was issued.
• The shareholder must have purchased the stock and not received it as compensation.
• Only the individual shareholders who purchased the stock directly from the corporation qualify for the special tax treatment.

For additional considerations, please reach out to Travis Koester, Associate, or contact our Tax Solutions team at Mahoney to be of help to you in any way.

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