There are several tax implications that you need to be aware of when shutting down a C corporation.
Complete liquidation of a C corporation is when it ceases to be a going concern, winds up its affairs, pays its debts, and distributes its remaining assets to the shareholder(s). In tax terms, the corporation redeems all its stock, and during the redemption, there can be one or more distributions pursuant to a plan.
While not mandatory, having a written plan is advisable because it establishes a specific start date for the liquidation process. This helps differentiate between regular dividends and liquidating distributions.
There are three ways your corporation can achieve liquidation:
1. Distribute all of the corporation’s assets to the shareholder(s).
2. Sell all its assets, and distribute the proceeds.
3. Sell some assets, and distribute the resulting sales proceeds and unsold assets.
The bottom-line federal income tax results for all these options are similar for the corporation and the shareholder(s).
If your corporation distributes property other than cash during liquidation, it must recognize taxable gain or loss as if the distributed property had been sold for its fair market value (FMV).
As a shareholder, you treat the liquidating corporate distribution as payment in exchange for your stock. You recognize taxable capital gain or loss equal to the difference between the FMV of the assets received and the adjusted basis of the stock you surrender.
The complete liquidation of a C corporation with appreciated assets often results in double taxation—once at the corporate level and again at the shareholder level. Hence, the timing could be critical depending on your situation and future changes in tax rates. As of 2023, the maximum individual federal income tax rate on long-term gains from a corporate liquidation is 20 percent, or 23.8 percent if the 3.8 percent net investment income tax applies.
In conclusion, once you decide on a complete corporate liquidation, the Board of Directors should adopt a plan and file Form 966 (Corporate Dissolution or Liquidation) with the IRS within 30 days of adopting the liquidation plan. The corporation should then file its final tax returns.
We specialize in helping clients clarify their taxes so they keep more of their money. Many small business owners who come to see us in Fort Worth, TX generally do not understand the tax law enough to explain it to a fifth grader.