Tax Consequences of a C Corp Liquidating Distribution

A liquidating distribution from a C corporation occurs when the company permanently ceases operations and distributes its remaining assets to shareholders. This process is different from a regular dividend, which is a distribution of profits from an ongoing business. The liquidation marks the end of the corporation’s life, and the distributions are the final transactions between the company and its owners, triggering distinct tax consequences for both parties.

Shareholder Tax Consequences

When a shareholder receives a liquidating distribution, the Internal Revenue Service (IRS) treats the event as a sale of their stock back to the corporation. The tax impact is calculated as a capital gain or loss, not as ordinary dividend income. The gain or loss is the amount of money and fair market value (FMV) of property received, minus the shareholder’s adjusted basis in the stock.

The amount realized is the total value a shareholder receives. This includes any cash distributed plus the FMV of any non-cash assets, such as real estate or equipment, on the date of distribution. For example, if a shareholder receives $20,000 in cash and a piece of land valued at $80,000, their total amount realized is $100,000.

A shareholder’s adjusted stock basis is generally the original purchase price of the stock, including any commissions or fees paid during the acquisition. To calculate the gain or loss, this basis is subtracted from the amount realized. If the amount realized was $100,000 and the shareholder’s stock basis was $40,000, the resulting capital gain would be $60,000.

The character of this gain or loss is capital. Its classification as short-term or long-term depends on how long the shareholder held the stock. If the stock was owned for one year or less, the gain or loss is short-term and taxed at ordinary income rates. If held for more than one year, it qualifies as a long-term capital gain, which is subject to more favorable tax rates.

Corporate-Level Tax Consequences

The tax implications of a liquidation extend to the C corporation itself, creating a separate taxable event. Under the tax code, a corporation that distributes its assets to shareholders in a complete liquidation is treated as if it sold those assets at their Fair Market Value (FMV).

The corporation calculates its gain or loss by subtracting its adjusted basis in the distributed assets from the FMV of those assets. For instance, if a corporation distributes a building with an FMV of $500,000 and a corporate tax basis of $200,000, the corporation must recognize a $300,000 gain. This gain is reported on the corporation’s final income tax return and is subject to corporate income tax.

This structure leads to a well-known feature of C corporations: double taxation. The first layer of tax occurs at the corporate level on the gain from the deemed asset sale. When the net assets are distributed to the shareholders, a second layer of tax occurs at the shareholder level on their individual capital gains.

The corporation’s recognized gain can be further increased if shareholders assume corporate liabilities as part of the distribution. The FMV of the distributed property is treated as being not less than the amount of the liability. This can inflate the deemed sale price and, consequently, the corporate-level tax.

Required Information and Tax Reporting

Navigating a C corporation liquidation requires specific reporting for both the shareholder and the corporation. Shareholders must gather data to calculate their capital gain or loss, including their adjusted stock basis, the stock’s purchase date, cash received, and the Fair Market Value (FMV) of any property received.

Shareholders will receive Form 1099-DIV from the liquidating corporation, which reports cash distributions in Box 9 and noncash distributions in Box 10. Using this form and their own records, shareholders must complete Form 8949, Sales and Other Dispositions of Capital Assets. The totals are then carried over to Schedule D (Form 1040) and filed with their personal income tax return.

The corporation must determine the adjusted tax basis and FMV for every asset being distributed and account for any liabilities transferred to shareholders. This data is necessary to calculate the gain or loss on the deemed asset sale. The corporation must notify the IRS of its intent to liquidate by filing Form 966 within 30 days of adopting a liquidation plan. The gain or loss is reported on the final Form 1120, and the corporation must also issue a Form 1099-DIV to each shareholder.

The Liquidation Process

The liquidation of a C corporation is a formal, multi-step process that must be executed in a specific order to comply with legal and tax requirements. The process generally includes the following steps:

• The board of directors and shareholders formally adopt a plan of liquidation. This resolution officially documents the corporation’s intent to dissolve and sets the start date for the liquidation period.
• The corporation files formal dissolution documents, such as Articles of Dissolution, with the state in which it was incorporated. This action legally terminates the corporation’s existence at the state level.
• The next phase involves the “winding up” of the business. This includes paying off all known corporate debts to creditors, collecting outstanding accounts receivable, and formally terminating business contracts.
• Once all third-party obligations are settled, the corporation distributes all remaining assets to its shareholders and files its final income tax return, marking the end of its existence.