Question

Due to age, retirement or failure of the business, many businesses must liquidate their assets and cease doing business.

What is the tax treatment to the business and the owners upon liquidation of the business when the business is a C corporation, an S corporation or a partnership?

Answer 1

Liquidation refers to binding up of a business over a time and selling its assets to the one who claims. It simply means to bring a business to its end and thereof selling its assets.

When a company is not making profits or running in loss, its better to close down the company. This is one of the common reason for liquidation.

But liquidation is not as simple as it seems to be. Liquidation is usually taxable for shareholders or the business. While selling off the assets, the businesses can have tax gain.

If we talk about C corporation, these are businesses where taxes are implied separate from their owners.

In this C corporation tax is implied first when the business had earned income which means taxes are implied on earnings of the business and again the taxes are implied when at the time of distributing dividends to the shareholders.

At the time of binding up the business, a C corporation pays a portion of dividend to its shareholders and the portion which is retained by the company is counted as either the tax gain for the business or as capital gain which means this is the capital gained by exchange of property or profit from the sale done by the business.

This way the business is able to save some money. Now, there are also some special cases. There are cases when a shareholder has taken some property which is as a liability for him, then at the time of paying dividend the amount of liability will be deducted from his dividend.

Now there are also few special rules where instead of paying the dividend, stocks are being sold or exchanged by the shareholders.

For the business, it is beneficial to pay dividends as they can have a tax shield in this. According to tax laws, dividends are only taxed once and hence the business can take advantage of this.

But if we see from owners or shareholders side, they would prefer to make redemption. In redemption they can sell or exchange their stocks at a price which could not have been possible if settled for dividend if the company had no earnings and profit.

If the price of stock has reduced from what it was initially it seems that going for redemption it will make loss but ultimately it can be deducted as for capital gain. Again we see how redemption is more beneficial.

At time, during liquidation the business distributes its assets to shareholders, it is not taxable.

Now moving on to S corporation, it is the business which is not separate from its owner for the purpose of taxation. They do not have any tax at corporate level instead they are only taxed at shareholders level. The income of S corporation is taxed to its owners, when income is earned to the business, therefore it is made sure that at the time of distributing earnings or dividend, owner's are not taxed, because earlier already there have been taxes when income was earned to the business, so here we see there is no tax at corporate level, but only at shareholders level, that too once.

This is the basic difference between S and C corporation and rest other are same. For tax implications at the time of liquidation.

Now moving towards the partnership, when any partnership business is going in loss, its owners feel to close down the company. This is the most common reason for liquidation of the business. One reason may be that the owners were planning to start a new business.

So in case of partnership liquidation, there are few things to noted. All the partners have put their own capital in the business and they have their own capital shares. Also the partners would be having some liabilities to be cleared. So at the time of liquidations, first, all the liabilities according to the agreement made by partners, each partner should pay their liability to the business so that no debt is remaining to be paid to business. After debts being cleared, the assets which belong to the business and are not liquid assets, they have to be sold for a price. The income which is Received or the loss that would have been incurred during their sell, should be accordingly distributed among the partners according to the income ratio.

Now the cash belonging to the business which may be remain should also be distributed among tha partners according to their capital ratio, that is the ratio in which capital was being pulled up by the partners in the business.