Tax implications of liquidating a corporation
The United States Tax Court generally applies a three part test in determining whether there was a plan to liquidate: 1) Was there a manifest intent to liquidate; 2) Was there a continuing purpose to terminate corporate affairs and dissolve; and, 3) Were the corporate affairs confined and directed to the purpose of liquidation.Substance over form will control the analysis of whether a corporation has completely liquidated, and the facts will control this analysis.The Complete Liquidation of a C Corporation Many business owners and shareholders of corporations will ask their tax attorney and/or business attorney, “what is a complete liquidation, and what are the tax implications to the C Corporation and the shareholders upon a complete liquidation?” I always find it interesting, maybe even ironic that the term “Complete Liquidation” is not defined in the Internal Revenue Code, and nor is it defined in the applicable Section 331 regulations.However, Federal Tax Regulations § 1.332-2(c) holds: A status of liquidation exists when the corporation ceases to be a going concern and its activities are merely for the purpose of winding up its affairs, paying its debts, and distributing any remaining balance to its shareholders.A liquidation may be completed prior to the actual dissolution of the liquidating corporation.Such an election is generally made by mutual agreement of the parties (if the Company is an S corporation, however, all of its stockholders must consent to the election).If such an election is made, the Company’s stockholders determine their tax consequences as if the Company had (i) sold its assets for the amount paid for the Company stock in the qualifying sale or sales (grossed up if less than all of the outstanding stock of the Company has been sold in such qualifying sale or sales) plus the amount of the Company’s liabilities and then (ii) liquidated, distributing its assets (the proceeds of its deemed asset sale) to the stockholders.
below (“Stock sale treated as asset sale”), a stock purchase has no effect on the tax bases of the Company’s assets. When the dust settles, the selling stockholders have the purchase price, and the Company is owned by the purchaser.Instead, the purchaser takes a basis in the stock purchased equal to the amount it pays for the stock, and the taxable income inherent in the Company’s assets remains inherent in the assets. At least from a tax standpoint, if the Company is a corporation, the purchaser will generally prefer to structure the transaction as a purchase and sale of the Company’s assets (rather than as a purchase and sale of the stock of the Company).That way, the purchaser can “write up” the tax bases of the Company’s assets and thereby report greater depreciation and amortization deductions with respect to, and smaller amounts of gain (or greater amounts of loss subject to any applicable limitations) on re-sales of, the purchased assets. In an asset sale, the Company is treated as selling, and the purchaser is treated as buying, the various Company assets separately for allocable portions of the aggregate purchase price.Any remaining gain or loss a selling owner of the Company may have on the sale is generally capital gain or loss under Code Section 741.In an asset sale, the Company is treated as selling, and the purchaser is treated as buying, the various Company assets separately for allocable portions of the aggregate purchase price.
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IRC § 346(a) also allows for a series of distributions that are pursuant to a plan of liquidation to constitute a formal liquidation of the corporation.