Yes, liquidation is a taxable event for both the shareholder and the corporation. A C corporation may liquidate by (a) paying off creditors and distributing the remaining assets in kind to the shareholders or (b) selling assets, paying off creditors, and distributing the remaining cash to the shareholders.
Note that if the corporation distributes the assets to the shareholders in kind pursuant to a plan of liquidation, it is treated as having sold the assets to the shareholder for fair market value. But if the corporation instead sells the assets and distributes the remaining cash to the shareholder, it is taxed on the sale.
In the same vein, the shareholder is treated as though the shareholders sold their stock to the corporation for the value of the assets or cash received. Have it in mind that the shareholder’s basis in property received pursuant to a plan of liquidation is the fair market value of the property at the time of the distribution.
What Happens When You Liquidate a C Corporation to Form an LLC?
However, if the plan is to liquidate a C corporation and form an LLC, in most cases, the tax consequences will be negative. The corporation is expected to recognize a gain on any appreciated property. Depreciation is more or less recaptured on the basis of the fair market value of the assets.
Also, loss on depreciated property is also recognized. Any gains are then taxable to the shareholders, less the shareholder’s basis or investment in stock. Even though it is possible to avoid a complete liquidation through joint ventures or parallel operations, the IRS might rule that the corporation has been constructively liquidated, resulting in additional tax.
In addition, a C corporation that meets the IRS qualifications may apply for S corporation status. So instead of taxing both the corporate earnings and the distributions to the shareholders, S corporation income is not taxed on the corporate level. And upon liquidation, any gain on the sale of assets will be passed to the shareholders.
But if the corporation was a regular C corporation before it received S corporation status tax consequences might result for assets that appreciated in value while operating as a C Corporation. Also note there may be state income taxes to consider too. Special tax rules apply if the corporation sells assets on the instalment method and distributes the resulting notes receivable to the shareholders as part of the liquidation process.
4 Rules and Guidelines for Liquidation of a C Corporation
Note that liquidation is the last step in the formal process of dissolving a corporation, irrespective of the number of shareholders it has. Liquidating a C Corporation more or less relates to how a corporation distributes assets that remain after taking care of outstanding debts. However, remember that the IRS regulations that apply to all corporations, as well as rules in the corporation’s home state tend to determine how liquidation must be handled.
Even though most state rules tend to be similar, it is always advisable to consult your secretary of state for the corporation’s home state to know and understand the state – specific information on corporate liquidation rules and regulations.
Table of Content
1. Putting Together a Liquidation Plan
Every state in the United States has specific requirements in terms of the information a liquidation plan must include. However, a liquidation plan is expected to outline a corporation’s promise to return excess assets to shareholders as specified in state regulations and identifies the date shareholders cease to have rights beyond receiving a final distribution.
Also note that a liquidation plan is expected to state the various procedures for dealing with distributions when the shareholder cannot be located. It more or less often involves transferring funds to the state for safekeeping until the shareholder comes forward.
In most states, the law mandates corporations that have any degree of liquidity after paying creditors and satisfying tax obligations to return excess funds to shareholders. Since leftover liquidity tend to include cash and capital or other assets the corporation has the legal right to sell, most distributions are completed in a series of increments.
However, irrespective of the amount available, it is expected to be totalled and divided proportionately among shareholders according to the number of shares each shareholder owns. In exchange, the shareholders are expected to return their outstanding shares to the corporation.
3. Know Your Tax Clearance Rules
In the United States, corporations are mandated by law to verify that final state taxes have been paid before liquidation can be considered complete.
Before and unless the corporation submits a letter or certificate obtained from the state tax agency explicitly showing that the business has no outstanding tax liability, the secretary of state will more or less not allow the corporation to be formally dissolved or liquidated. Note that this can also entail that the corporation remains responsible for paying annual fees and complying with annual reporting requirements.
4. IRS Filing Requirements
The IRS Regulation 4.11.7 explicitly states filing requirements and outlines corporate responsibilities for recognizing gains or losses on the liquidation of each business asset. For instance, IRS Form 966, Corporate Dissolution or Liquidation, is expected to be filed within 30 days of filing the initial articles of dissolution. In addition, shareholders receiving distributions of $600 or more in a calendar year are expected to receive a 1099 – DIV.
Immediately the liquidation proceedings are complete, IRS Rule 71 – 129 mandates all corporations to file a final corporate tax return and pay any outstanding tax liability on or before the 15th day of the third full month following the dissolution. For instance, if liquidation is complete on Jan 26, the final tax return is due on April 15 of the same year.
As you can see, C Corporation liquidation can indeed trigger income tax bills at both the corporate and shareholder levels. In other words, double taxation may apply. If so, the combined corporate – level and shareholder – level tax bills may be surprisingly expensive. Howbeit, advance planning can often help you achieve better tax results.
Also, it may be possible to structure an asset sale in a way that doesn’t involve a corporate liquidation if that would mean lower taxes. It is always advisable to consult with your tax advisor to develop the best strategy for your corporation and its shareholders.