Question

Know the treatment of liquidating distributions to the corporation and to shareholders. Be familiar with how they differ from redemption distributions.

Answer 1

Treatment of liquidating distributions

Gain or loss on receipt of property from liquidating corporations

Amount = fair market value of property received - basis in stock .

A liquidating distribution is considered to be full payment in exchange for the shareholder’s stock, rather than a dividend distribution, to the extent of the corporation’s earnings and profits (E&P). The shareholders generally recognize gain (or loss) in an amount equal to the difference between the fair market value (FMV) of the assets received (whether they are cash, other property, or both) and the adjusted basis of the stock surrendered. If the stock is a capital asset in the shareholder’s hands, the transaction qualifies for capital gain or loss treatment.

A liquidating distribution is considered to be full payment in exchange for the shareholder’s stock, rather than a dividend distribution, to the extent of the corporation’s earnings and profits (E&P). The shareholders generally recognize gain (or loss) in an amount equal to the difference between the fair market value (FMV) of the assets received (whether they are cash, other property, or both) and the adjusted basis of the stock surrendered. If the stock is a capital asset in the shareholder’s hands, the transaction qualifies for capital gain or loss treatment.

If the corporation sells its assets and distributes the sales proceeds, shareholders recognize gain or loss when they receive the liquidation proceeds in exchange for their stock. If the corporation distributes its assets for later sale by the shareholders, the assets generally “come out” of the corporation with a basis equal to FMV (and with the related recognition of gain or loss for the difference between the FMV and the shareholder’s basis in the stock). As a result, the tax consequences of a subsequent sale of the assets by the shareholder should be minimal.

The result of these rules is double taxation. The corporation is treated as selling the distributed assets for FMV to its shareholders, with the resulting corporate-level tax consequences. Then, the shareholders are treated as exchanging their stock for the FMV of the assets distributed in complete liquidation, with the resulting gains or losses at the shareholder level.

The liquidating distributions are very much different from redemption distributions .

Redemption distribution means repayment of any money market fixed-income security at or before the asset's maturity date. Investors can make redemptions by selling part or all of their investments such as shares, bonds, or mutual funds. In business and marketing, however, consumers often redeem coupons and gift cards for products and services.