ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

A Quick Guide to Corporate Liquidations

Updated on November 12, 2012

Complete Corporate Liquidations

There comes a point for most businesses when it’s time to throw in the towel. Maybe the economy is down and the business can’t weather the downturn. Maybe the owners want out and there’s no buyer available. Either way, the business is done, and the owner is trading in all of their shares and taking cash or other property out of the business. The question is how can this impact the shareholders taxes? With the C Corporation structure, the tax effects occur at two levels, the shareholder and the corporation. It’s this double taxation that makes C corps an organization of last resort for most businesses.

One issue that arises is that the term “Complete liquidation” is never explicitly defined by the Internal Revenue Code.

According to the regulations regarding Section 332, the business is considered to have completely liquidated when it ceases to be a going concern and exists only to wrap up its business. But that can be a rather nebulous definition. Many businesses limp along, making little or no revenue, struggling to pay debts but take years to finally close. So at what point does the tax code draw the line? Well the Tax Court has defined a three part test to help clarify. First, there has to be intent to liquidate, as shown by a written statement from the Board of Directors and signed by shareholders that clearly define the intent to close the business. Second, was there a continuing purpose that focused on wrapping up the affairs of the business and dissolving it? Third, did the business activities further the goal of liquidating, or does there appear to be attempts to grow or maintain the business. One other point to remember is federal tax law and state incorporation laws are not bound together. Dissolving your business at the state level without submitting your dissolution to the IRS can have tax consequences later on for the shareholders. Also, choosing not to dissolve the business at the state level can complicate things. Yes, you can leave the business intact for state purposes, but understand that the IRS will watch to see if you have essentially restarted the same business. If they decide you have, then what was originally a capital gain could now be taxed as ordinary income in its entirety.

Let’s look at the effect on the shareholder first.

Shareholder Level

On the shareholder level, a complete liquidation is essentially a sale of all the outstanding shares of corporate stock held by the shareholders in exchange for all the assets of the corporation. Just like any other sale of stock, the shareholder gets capital gains treatment on the difference between their adjusted basis in the stock (i.e. their cost) and the amount they received from the liquidation. Any amount received is determined at fair market value, so cash fairly straight forward. But what if the shareholder receives property other than cash? Maybe the business can’t find a buyer for an asset and simply distributes it to the shareholder.

Because the exchange of stock for property in liquidation is considered a sale, property received is valued at fair market value. Let’s say that the corporation decides that rather than sell the company car, which was bought in 2011 for $5,000 and is currently valued at $4,000, they are going to give it to the shareholder, who has a basis in his stock of $3,000. The shareholder will recognize capital gain of $1,000. And what is the shareholder’s basis in the car? It is $4,000, just as if he had bought the car rather than received it in a distribution. Similarly, his holding period starts as of when the liquidation occurred and the sale is deemed to have occurred.

When does a gain or loss on the liquidation have to be recognized? If it’s a gain, the IRS says it should be recognized as soon as the shareholders basis has been recovered. If it’s a loss, however, it isn’t recognized until the final distribution has been made. This way a shareholder can’t manipulate the timing in order to take a loss early and as well as gain later.

Corporate Level

What about the corporation that has liquidated? I already mentioned that corporate liquidations, like most corporate issues, are taxed twice, once at the shareholder level and once for the corporation. For that reason, the liquidating corporation also has to recognize gains or losses associated with the distribution of assets. Let’s look back at our car. We said the car was purchased for $5,000 and the fair market value was $4,000. The company had used MACRS to depreciate the car and it had a book value of $3,000. How much gain or loss will the company recognize? The company will recognize a GAIN of $1,000, the variance between the adjusted basis in the car and the fair market value. It is important to remember that this calculation is made for each asset distributed. You cannot take the aggregate and say, we distributed 5 cars to the shareholder for a total of $X and they had a total basis of $Y, so our gain is… The gain and loss must be calculated separately for each asset.

Another point to remember is that when a business is liquidating, the IRS considers the business to be switching from being an accrual basis to a cash basis for reporting purposes, which makes sense when you think about it. If you plan to dissolve your business, you are not likely to allow people to buy on credit, nor are you likely to start prepaying expenses and assuming more liabilities. Converting from accrual to cash brings everything into the present period and allows the corporation to track income and expenses. But what if you do have receivables on the books?

The IRS applies the assignment of income doctrine, which means that the rights to receive income cannot be transferred to someone else. Therefore the corporation will be taxed on the outstanding receivables, not the shareholder.

Another issue involves businesses in construction contracts. Let’s say that you build airplanes, a process that could take longer than a year. Normally you recognize income on a completed contract basis. Because this method is intended to recognize income that was earned on an accrual basis, you would have to switch to a percentage of completion method, which recognizes income more closely to a cash basis.

And so there you have a quick introduction to complete corporate liquidations. Generally they are pretty straight forward, but it is always valuable to consult with a CPA or tax attorney to make sure everything is done correctly. There are different rules for S corps, for subsidiaries and for partnerships. I will eventually tackle those topics as well. If you find anything here that is in error, or could use further clarification, please let me know. I’m happy to incorporate feedback.

Comments

    0 of 8192 characters used
    Post Comment

    • profile image

      Rahima 3 years ago

      Hi FernandoI am not sure how to handle this sioiutatn in the US as I am involved with Canadian tax returns. In Canada, if you discover that you made an error on your tax return, you can do a T1 adjustment to file the correction. I believe it is better to do the correction on your own as opposed to wait for the government to find the error and reassess you as no matter how long it takes, they will find the error and charge you interest for the unpaid balance.

    • profile image

      Alex 3 years ago

      Sole propriety and sclduehe C Business income tax Profit and loss sclduehe is for you to use as a taxpayer with your own self employed income and expenses. You and yours would be the same individual taxpayer for this purpose. But what if you realize that you have done completed and signed and incorrectly filled out 1040 income tax return that you filed to the IRS and also that you have already received a income tax REFUND for this incorrectly completed 1040 income tax return? I really believe that the IRS will be taking careful watch for this very problem. Perhaps you should also be consulting with your trustee of your bankruptcy estate account. Does that sound about right Paul?

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: "https://hubpages.com/privacy-policy#gdpr"

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized. (Privacy Policy)
    CloudflareThis is used to quickly and efficiently deliver files such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisements has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)