Tax treatment of liquidating distribution

The tax treatment of the shareholders is governed by the tax code’s Section 331(a), which provides that amounts distributed in complete liquidation, “shall be treated as in full payment in exchange for the stock.” Generally, stockholders record a gain (usually capital in nature), if the net distributions of the surrendered stock is greater than the shareholder’s adjusted basis in the stock. If state law allows a dissolved company to own assets, the dissolution, unless accompanied by an actual conveyance of the entity’s assets to its shareholders, will not give rise to a liquidation.

Conversely, the stockholders record a loss (also, almost always a capital loss), if the net distribution is less than their adjusted basis in the stock surrendered in the transaction. Indeed, in that situation, the tax consequences spelled out in ( Section 331(a) and Section 336(a) will not be visited on the shareholders and the corporation, respectively.** Federal Law Governs The ruling concludes that the “core test of corporate existence,” for purposes of federal income taxation, is always, a matter of federal law.

Creditors are always senior to shareholders in receiving the corporation's assets upon winding up.

However, in case all debts to creditors have been fully satisfied, there is a surplus left to divide among equity-holders.

For example, suppose the company vehicle is worth ,000 rather than ,000.

In that case, the distributee shareholder is another corporation which owns at least 80 percent of the voting power and value of the liquidating entity’s stock on the date of the planned complete liquidation is adopted and all times thereafter until the receipt of the property.) **When a complete liquidation is followed by a pre-arranged transfer of all or part of its essential operating assets to a second (almost always newly-created) controlled corporation, the steps may be “collapsed” and treated as a single, unitary transaction which bears an unmistakable resemblance to a reorganization. 1.331-1(c) “…a liquidation which is followed by a transfer to another corporation of all or part of the assets of the liquidating corporation…may have the effect of…a transaction in which no loss is recognized and gain is recognized only to the extent of other property…”) In LTR 200806006, however, it is highly unlikely that, if the dissolution had caused a liquidation, such liquidation would have been “stepped together” with the reincorporation (to find a reorganization). When a company has more liabilities than assets, equity is negative and no liquidating distribution is made at all.This is usually the case in bankruptcy liquidations.Such a transaction is popularly known as a liquidation/reincorporation. In the instant case, the corporate taxpayer would have been unaware of the fact that it had been completely liquidated and, thus, its eventual reincorporation, in belated response to such liquidation, could not be seen as part of a unitary transaction which encompassed both the liquidation and reincorporation. (See Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders at Para.

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