Tax on a liquidating distribution

Other forms of ownership, such as limited liability partnerships, have replaced the traditional C corporation structure for many small businesses.

If you decide to change to another form of business organization, close your operations permanently or sell your business to another, you will likely need to liquidate the corporation.

Can you tell me how this type of transaction should be treated for tax purposes?

A: Internal Revenue Service spokesman Jesse Weller says liquidating distributions are considered a return of capital.

If it is considered terminated, the company would have been viewed as having completely liquidated, and both it and its shareholders would have experienced the tax consequences attendant to the situation. In other words, in most cases, the liquidation of a corporation commonly engenders two levels of taxation: tax will be imposed at both the corporate and distributee shareholder levels.* The De Facto Company Closure A complete liquidation is not always accompanied by a formal or legal company shutdown. Thus, unless dissolution brings about an automatic transfer of the corporation’s assets to its shareholders, the corporation, even though dissolved, continues its existence.

Forming a C corporation was once the only way the owner of a small business could shield himself from the debts and liabilities of the company.

This mainly occurs during voluntary liquidations of solvent corporations.

At issue is whether the company’s status as a corporation had been terminated by the administrative dissolution. Something else to consider is that under Section 336(a) of the tax code, a gain or loss is recognized by a liquidating corporation on the distribution of its property in complete liquidation, as if such property were sold to the distributee at its fair market value. 142 ) states that “…where a corporation ceases business operations, has retained no assets, has no income, and has actually liquidated, there is in effect a de facto dissolution, even though the corporation has not been formally dissolved…” In addition, it is entirely possible for the corporation to continue in existence even though it has been, as a matter of state law, dissolved.Selling a corporation involves both stock and the company's assets.Shareholders might prefer to sell their stock, but buyers might be more interested in the assets.But for tax purposes, the defining line can make a big difference.Witness the situation described in recent letter from the Internal Revenue Service (LTR 200806006, November 7, 2007), which addresses a seeming anomaly related to the tax code.