The tax effects to shareholders of liquidating a corporation are largely governed by IRC Sections 331, 332 (liquidations of subsidiaries) and 338 (dealing with certain stock purchases treated as asset acquisitions). This article will examine only the general tax rule found in Section 331 (keep in mind that there are numerous exceptions and variations depending on your particular tax situation).
In the case of distributions in a complete liquidation of a corporation, IRC Section 331(a) provides that amounts (or assets) received by shareholders shall be treated as “full payment in exchange for the stock”. In other words, these amounts (or assets) are deemed as a sale or exchange of assets distributed in return for stock. Therefore, the shareholders will need to recognize gain or loss on the difference between the fair market value of the asset distributed to them and the adjusted basis of the stock that they surrendered.
IRC Section 1101 is the general rule for the amount of gain or loss to be recognized. Pursuant to that section, if the stock is a capital asset to the shareholder, then a capital gain or loss will result. Similar to the general tax rules in a sale or exchange, the basis of the property distributed to shareholders in a complete liquidation will be the fair market value of the property on the date of distribution.
It is very important that the transaction is properly documented. The shareholder are responsible for providing evidence of the adjusted basis of the stock. However, if such evidence is not provided, then the IRS may treat the stock as having a zero basis, and the entire fair market value amount of the liquidation proceeds will thus constitute the gain to be recognized by the shareholder.
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This article covers only some general information with respect to the tax effect of a complete liquidation of a corporation on its shareholders; the article does not offer any legal advice and it should not be relied upon to determine the tax obligations in your particular situation.
If you have any questions or concerns regarding U.S. corporate taxation laws and regulations, contact Sherayzen Law Office for legal help. Our experienced corporate tax attorneys will guide you through even the most complex corporate transactions and help you properly document such transactions as required by the Internal Revenue Code as well as relevant business laws and regulations.