“I’ve been reading about corporate liquidations”, you mention to your financial planner. “The corporate liquidation tax consequences seem complex, should I steer clear?” “Good question”, she replies, “go to Event Driven Daily and get the particulars, then decide.”
Corporate Liquidation Tax Consequences: Should Shareholders Worry?
Shareholders should worry about corporate liquidation tax consequences, as it can result in significant tax liabilities. Corporate liquidation is the dissolution of a company and the distribution of its assets to shareholders. Corporate liquidation tax consequences can adversely impact shareholders, so it is imperative to understand these implications. Here are the key particulars shareholders should consider:
Double Taxation – US corporate liquidations trigger a dual taxation event.
- Corporate Taxable Event – When a corporation sells its assets at fair market value to distribute to shareholders, it must recognize any capital gains or losses.
- Shareholder Taxable Event – Shareholders are responsible for reporting the capital gains or losses on the receipt of any liquidation proceeds (cash or real property). If the firm chooses to distribute these proceeds as dividends, the liquidation proceeds will be treated as ordinary dividend income for tax purposes and not as capital gains.
Taxable Event Timing – Liquidation proceeds distribution can affect the tax year in which the taxable event is recorded. Shareholder’s tax liability is time-sensitive, and they must be cognizant of the timing, hence the tax reporting responsibility, of the liquidation.
Gains and Losses – Liquidation distributions are capital gains or losses. Whether the capital gains are taxed at the higher short-term gains tax rate, or the lower long-term capital gains rate is dependent on your holding period of your original investment in the liquidated company. If you invested one year prior to receiving liquidation proceeds, your capital gains are taxed at a lower rate, receipt of liquidation proceeds on investments held less than a year are subject to the higher short-term tax rate.
Tax Treatment of Capital Losses - Losses are not subject to different tax treatment based on holding periods.
- Offsetting Gains - Capital losses, short or long-term, can be used to offset capital gains. Some shareholders have both capital gains and losses, in which case the losses are applied against matching gains, i.e. short-term losses applied to short-term gains and long-term losses against long-term gains.
- Ordinary Income Deduction - If capital losses exceed capital gains, up to $3,000 ($1,500 if married filing separately), the excess loss can be deducted against ordinary income each year.
- Carryforward – Capital losses can be carried forward to offset any future capital gains or ordinary income up to the annual maximum of $3,000.
Distribution Installments – Liquidation proceeds that are distributed in installments allow shareholders to effectively manage their tax burden by spreading out the tax liability over an extended period.
Shareholders should indeed be concerned about corporate liquidation tax consequences. Consulting with tax professionals and financial advisors is crucial and prudent to navigate the complexities of the liquidation process and optimize your tax outcomes.
Read next: Why Would You Liquidate a Company?
