IRS Section 331: Shareholder Tax on Corporate Liquidations
Learn how IRC Section 331 treats corporate liquidation distributions as a taxable exchange for stock, establishing the framework for a shareholder's capital gain or loss.
When a corporation ceases operations and distributes its assets to shareholders, it undergoes a complete liquidation. This process has specific tax consequences for shareholders receiving the distributions. These tax implications for shareholders are governed by the Internal Revenue Code (IRC).
Shareholder Tax Treatment
Under IRC Section 331, distributions from a complete corporate liquidation are treated as if the shareholder sold their stock back to the corporation, not as a regular dividend. This treatment results in a capital gain or loss for the shareholder. The holding period of the stock determines the nature of the gain or loss.
If the stock was held for more than one year, the gain or loss is long-term. If held for one year or less, it is short-term. Long-term capital gains are often taxed at lower rates than short-term gains, which are taxed at the shareholder’s ordinary income tax rate.
Calculating Gain or Loss
A shareholder’s gain or loss is calculated with a specific formula: the Amount Realized from the distribution minus the shareholder’s Adjusted Basis in the stock. The Amount Realized is the total value a shareholder receives, including cash and the Fair Market Value (FMV) of any property. FMV is the price that property would sell for on the open market. A shareholder’s Adjusted Basis is generally the original purchase price of their stock.
For example, if a shareholder’s basis is $10,000 and they receive $15,000 in cash and property with an FMV of $20,000, their Amount Realized is $35,000. The taxable gain would be $25,000, which is the $35,000 Amount Realized less the $10,000 Adjusted Basis.
Reporting the Liquidation
Shareholders must report the transaction on their personal tax return. The liquidating corporation issues Form 1099-DIV to each shareholder, which specifies the value of distributions. Cash distributions are reported in Box 9, and noncash distributions are in Box 10.
The shareholder uses this information to complete Form 8949, “Sales and Other Dispositions of Capital Assets.” On this form, the shareholder lists the proceeds, cost basis, and relevant dates to determine if the gain or loss is short-term or long-term. The totals from Form 8949 are then transferred to Schedule D, “Capital Gains and Losses,” to calculate the final tax liability or loss deduction.
Exceptions to Standard Treatment
An exception to this taxable treatment exists for the liquidation of a subsidiary corporation into its parent company, governed by IRC Section 332. Under this rule, the parent corporation generally does not recognize gain or loss upon receiving the subsidiary’s assets. This provision allows corporations to simplify their structures without immediate tax consequences.
For Section 332 to apply, the parent corporation must own at least 80% of the subsidiary’s voting power and stock value. This ownership must be maintained from the date the liquidation plan is adopted until the final distribution. The asset transfer must also occur within a specific timeframe, either within a single taxable year or as a series of distributions completed within three years from the close of the taxable year of the first distribution. If these conditions are met, the liquidation is a non-taxable event for the parent shareholder.