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BK-CPA
BK-CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 793
Experience:  Owner of a CPA firm
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c corporation tax consequences of a liquidating cash distribution

Resolved Question:

c corporation tax consequences of a liquidating cash distribution on the shareholders. How is the ending stock basis calculated?
Submitted: 3 years ago.
Category: Tax
Expert:  BK-CPA replied 3 years ago.

BK-CPA :

Hello and thank you for your question.

BK-CPA :

Dividend distributions to C-Corp shareholders will be treated as a sale or exchange in complete liquidation of the stock, generally. The internal revenue code addresses this directly here:

BK-CPA :

§ 331. Gain or loss to shareholders in corporate liquidations





(a) Distributions in complete liquidation treated as exchanges
Amounts received by a shareholder in a distribution in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock.


BK-CPA :

Hello and welcome to the chat. I'll give you a second to catch up.

BK-CPA :

Please let me know.

JACUSTOMER-2ydwacvw- :

Shareholders have a basis in the stock of the C-corporation? What are the details of c corporation stock basis?

BK-CPA :

Good question.

BK-CPA :

That's next. Further review of IRC 331 leads us to IRC 1001 and 1011, here (you may wish to open these links in a new tab or window, sorry).


 

BK-CPA :

The later of the two sections describes how you calculate basis:

BK-CPA :

§ 1011. Adjusted basis for determining gain or loss





(a) General rule
The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis (determined under section 1012 or other applicable sections of this subchapter and subchapters C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses)), adjusted as provided in section 1016.


BK-CPA :

Again, please let me know when you've had time to read.

JACUSTOMER-2ydwacvw- :

The C Corp I am working with just went thru an asset sale of the company and will report the gain on sale. All that is left to distribute is cash. After all entries are made, gain on sale, taxes paid, etc we have left common stock and retained earnings. This is the shareholder basis of stock?

BK-CPA :

The shareholder's basis in the stock is unique and calculated separately for each shareholder.

BK-CPA :

You cannot look at a corporate balance sheet and know what the shareholder's individual bases are.

BK-CPA :

Generally.

BK-CPA :

The shareholders will pay capital gains (note IRC 1202 stock here for capital gain exclusion potential) on the difference between their individual bases in the stock and the cash they receive.

BK-CPA :

Per IRC 1011 above, you can refer to the cost basis description in IRC 1012, and also note subchapter C here:

BK-CPA :

§ 1012. Basis of property—cost





The basis of property shall be the cost of such property, except as otherwise provided in this subchapter and subchapters C (relating to corporate distributions and adjustments), K (relating to partners and partnerships), and P (relating to capital gains and losses). The cost of real property shall not include any amount in respect of real property taxes which are treated under section 164 (d) as imposed on the taxpayer.

JACUSTOMER-2ydwacvw- :

Is basis calulated as would be in a partnership or s-corp? based on percentage of ownership and contributions to the corp, loans etc. I mostly work with S-corp and partnerships - basis calculation for C corp stock is the same? I think I am making this more complicated than needs be?

BK-CPA :

Corporations don't always make liquidating distributions. Dividends can be out of E&P, they can reduce shareholder basis, or they can become capital gains to shareholders along the way.

BK-CPA :

See here:

BK-CPA :

(c) Amount taxable


In the case of a distribution to which subsection (a) applies—

(1) Amount constituting dividend
That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income.


(2) Amount applied against basis
That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock.


(3) Amount in excess of basis
(A) In general
Except as provided in subparagraph (B), that portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property.


BK-CPA :

I therefore will not be able to tell you what your individual shareholder bases are, but just how to calculate them... please let me know again when you have had a chance to catch up.

BK-CPA :

...To answer your question, no, there are differences between the mechanics of tracking shareholder basis between C-Corps, S-Corps, and partnerships.

JACUSTOMER-2ydwacvw- :

This corp is new to me - but I have worked with the shareholders individually and to my knowledge only one dividend has been paid, a 1099-DIV was prepared and distributed. If I understand correctly - a liquidating dividend is different the a regular dividend in that the dividend is taxed only to the extend the amount exceeds stock basis. I need to get a handle on the stock basis calculation.

BK-CPA :

In general, you are correct, yes.

BK-CPA :

Dividends come first from earnings and profits of the corporation, then from the shareholders' individual bases, and then, finally, for dividends in excess of basis, shareholders recognize capital gain. This is for 'regular' or non-liquidating distributions in general.

BK-CPA :

A liquidating distribution is, per the above section, treated like a sale or exchange in redemption of stock.

JACUSTOMER-2ydwacvw- :

The corp is sold and no longer doing business, so the liquidating dividend would be a sale of stock. I might have missed this answer - is there a list or an ordering of stock basis calculation? If no outside events happened to the shareholders individually - wouldn't the basis come from the balance sheet by each shareholders percentage? I am more than willing to pay extra for your time and patience.

BK-CPA :

The stock basis is going to be what shareholders paid for the stock originally it sounds like. You said you only had one dividend. Did that dividend reduce that shareholder's stock basis per IRC 301 above?

BK-CPA :

In other words, if I buy stock for $10,000 and receive $20,000 in a liquidating distribution, I will have $10,000 in capital gains (and again, I'd be looking to apply IRC 1202).

BK-CPA :

Here is IRC 1202 by the way:

BK-CPA :

§ 1202. Partial exclusion for gain from certain small business stock

BK-CPA :

(a) Exclusion


(1) In general
In the case of a taxpayer other than a corporation, gross income shall not include 50 percent of any gain from the sale or exchange of qualified small business stock held for more than 5 years.

BK-CPA :

Are you with me?

JACUSTOMER-2ydwacvw- :

Yes, I am looking at a balance sheet with common stock of $4,445; total capital of $1,344,934. This is retained earrnings; gain on sale of corp assets etc.

BK-CPA :

The corporation has to pay the gains on the 'asset sale' while the shareholders receive liquidating distributions of cash (taxed at capital gains rates if in excess of their basis). I believe this is what you mean, correct?

JACUSTOMER-2ydwacvw- :

Yes. Is my total capital & equity the basis of the stock after all is said and done?

BK-CPA :

No. The corporation will have basis in the money equal to its equity... The shareholders have basis in their corporate stock based on what they paid for it.

BK-CPA :

S-Corporations pass through the earnings to shareholders, as do partnerships, and this changes the partners' bases from year to year, but C-Corps pay their own taxes.

BK-CPA :

Things are different there...

JACUSTOMER-2ydwacvw- :

So the shareholder basis is the $4,445 is common stock. I was thinking that was what you were saying.

BK-CPA :

There is generally common stock, additional paid in capital, and then, finally, retained earnings.

BK-CPA :

The common stock and additional paid in capital would general comprise the basis of the shareholders.

JACUSTOMER-2ydwacvw- :

So retained earnings is part of the shareholders stock basis?

BK-CPA :

What happens if a shareholder contributes $10,000 (therefore starting with a basis of $10,000), and I buy his shares for $20,000. My basis then becomes $20,000, but nothing has changed on the corporate balance sheet. Follow me there?

JACUSTOMER-2ydwacvw- :

yes

JACUSTOMER-2ydwacvw- :

the second person has outside basis

BK-CPA :

Each shareholders basis will be unique. The corporation keeps track of E&P for dividend purposes per above (dividends are income to receipients out of E&P), but otherwise the liquidation is like a sale of the stock.

BK-CPA :

The sale of stock results in capital gains.

BK-CPA :

Generally.

JACUSTOMER-2ydwacvw- :

okay, so the money distributed (over a million dollars! yikes) is partially a dividend taxed as a regular dividend and partially a sale of stock($4,445).

BK-CPA :

No, because this is a complete liquidation.

JACUSTOMER-2ydwacvw- :

so the distribution is taxed on the gain over the $4,445. What happens to retained earnings???

BK-CPA :

The dividend rules of IRC 301 above do not apply in a complete liquidation per IRC 331 above. See IRC 331(b) here:

BK-CPA :

(b) Nonapplication of section 301


Section 301 (relating to effects on shareholder of distributions of property) shall not apply to any distribution of property (other than a distribution referred to in paragraph (2)(B) of section 316 (b)) in complete liquidation.
BK-CPA :

The corporation will distribute all of the money (ie, credit to cash) and eliminate any corporate equity (ie... debit to retained earnings).

JACUSTOMER-2ydwacvw- :

I think I get it - I need to read everything you sent me again. It will help me do write down the entries. Thank you so much for your time.

BK-CPA :

One last thing please:

BK-CPA :

Note IRC 6043 here:

BK-CPA :

and, per IRC 6043, Form 966 here:

BK-CPA :

Here is a quote from IRC 6043:

BK-CPA :

§ 6043. Liquidating, etc., transactions





(a) Corporate liquidating, etc., transactions
Every corporation shall—

(1) Within 30 days after the adoption by the corporation of a resolution or plan for the dissolution of the corporation or for the liquidation of the whole or any part of its capital stock, make a return setting forth the terms of such resolution or plan and such other information as the Secretary shall by forms or regulations prescribe; and

(2) When required by the Secretary, make a return regarding its distributions in liquidation, stating the name and address of, the number and class of shares owned by, and the amount paid to, each shareholder, or, if the distribution is in property other than money, the fair market value (as of the date the distribution is made) of the property distributed to each shareholder.


JACUSTOMER-2ydwacvw- :

Yes, thank you. I read and understood the reporting of corp liquidation. We knew the taxation of this sale was going to be brutal. I just wanted make sure I had a handle on the situation. The corp President is coming to the office tomorrow and we will go over all of the information.

BK-CPA :

You'll have your IRC sections ready!

BK-CPA :

Is there something more that I can clarify for you though?

JACUSTOMER-2ydwacvw- :

No, not at this time. Thank you. This is the first time I have used this service. You have been very helpfull. I am considering the monthly fee sign-up. Thanks again.

BK-CPA :

Thank you very much too!

BK-CPA :

I hope you find JustAnswers to be a worthwhile service.

BK-CPA :

If you think of something else, feel free to ask!

JACUSTOMER-2ydwacvw- :

Thank you

BK-CPA :

I will switch this to Q&A mode now, and you may come back to this if you like. Sound good?

Expert:  BK-CPA replied 3 years ago.
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Customer: replied 3 years ago.
my corp shareholders will qualify for the 50% exclusion for sale of small business stock. helps a little. thanks for you help.
Expert:  BK-CPA replied 3 years ago.

This article becomes a very good read. I'm thinking of the sunset provisions for the 7% AMT preference (AMTI = alternative minimum taxable income with respect to the alternative minimum tax, aka AMT):

 

Article:

 

http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2010/CorpTax/TaxExclusion_Expanded.jsp

 

"The Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L. 108-27) amended Code §57(a)(7), resulting in only 7 percent of the excluded gain being included in AMTI. This was effective for dispositions on or after May 6, 2003. A sunset provision reverts back the law to its original language for taxable years beginning after December 31, 2010. P.L. 108-27, §303, as amended by P.L. 109-222, §102."

 

Here is IRC 57(a)(7) being referred to in the article:

 

http://www.law.cornell.edu/uscode/26/usc_sec_26_00000057----000-.html

...

(a) General rule For purposes of this part, the items of tax preference determined under this section are-

...

(7) Exclusion for gains on sale of certain small business stock An amount equal to 7 percent of the amount excluded from gross income for the taxable year under section 1202.

 

..

 

...

 

 

 

Long story short, 2010 may be a good year if that is when the liquidation went/goes through.

 

Again, I hope this is helpful.

 

Thank you!

 

Customer: replied 3 years ago.
Yes, the article is very helpfull. We are down to the wire for tax law extensions, possibly, so we are trying not to miss anything. If all money is distributed and the 966 is filed with the IRS by the end of the year 12/31 will the liquidation be complete? They were talking about a partial distribution now and some next year - may not be a good idea. The company sold 3/31/2010.
Expert:  BK-CPA replied 3 years ago.

In general, the liquidation is complete for a shareholder when he/she forfeits the stock in exchange for the cash. The liquidation will take place for all shareholders at the same time, but as a technicality, it is the 'liquidation of the shareholders' interest' that will trigger the capital gain (assuming a corporation wanted to continue, it would be a purchase of the shareholder's stock directly as opposed to via a liquidation generally, should a single shareholder get bought out by the corporation or a third party). Because IRC 1202 applies to the gain recognized by shareholders, it is the timing of the shareholders' gain that should go through before 12/31/10...

 

In any case, what you are saying is correct. The corporation will file a final return too (check a box on Form 1120). The shareholders should all receive their $ before year end.

 

Again, I hope this is helpful.

 

Thank you for your questions!!

 

 

Customer: replied 3 years ago.

Yes, it is me, the C-corp problem. There is another complication. Clients can be complicated. The C-corp is a family business, the shares of stock are owned by a brother, sister and brother-in-law. Well, an agreement was signed between another sister and brother-in-law and son that they would own 10% of the company after 5 years. No stock was issued and nothing was paid in for ownership other than they were employees of the company. Well of course 10% of the liquidating dividend is to go to the 10% owner's. But I don't see how they could be stock owners when no stock was issued at the 5 year mark. Could their distribution be classifyied as a bonus, subject to payroll tax issues?

The information you gave me yesterday was so helpfull. Thank you. I hope you have some ideas on this one.

Expert:  BK-CPA replied 3 years ago.

Your perception seems good on this one with respect to the payroll taxes, though that will be based on personal circumstances. It can almost become a legal question too depending on how much fighting between family members goes on...

 

In any case, you could make someone a new shareholder this year if that is the deal, but you're going to have to justify your treatment then, because if no stock was issued and nothing was paid in for ownership, then it's either a gift or compensation as you note. Is this a gift and everyone agrees, as is supposed to happen (have happened)? If a gift, is this really just a tax avoidance scheme...? The related party rules would have losses disallowed on a sale of stock between family members, but gains would be recognized generally, and with a gift the basis would transfer to the recipient from the transferor if the fair market value of the stock exceeds the transferor's basis at the time of the gift. You don't want to give up your 1202 stock over this either...

 

This is a bit of a can of worms... I would suggest the family work this out amongst themselves in general and keep the tax stuff nice and clean. Make sense?

 

Thank you again!

 

Edit: I was thinking of my above response, and since a lot people get this confused, I will point out that we 'experts' on JustAnswers are users of the platform, like you, and not employees of JustAnswers or anything. I do hope you like JustAnswers!! I personally will be traveling this weekend, so I doubt I'll be around a computer, but other experts are here too and can assist if you ask a new question / opt me out at any time. Should you specifically want me or another expert to answer your question, you can request us and we'll generally answer if available (use the JA function or type "for so-and-so" at the beginning of your question. I do check my e-mail and try to respond when available. Thanks again!! Best of luck with this for now too!!!



Edited by BK-CPA on 12/10/2010 at 1:51 AM EST
BK-CPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 793
Experience: Owner of a CPA firm
BK-CPA and 2 other Tax Specialists are ready to help you
Customer: replied 3 years ago.

Thank you for your response, you clarified what I told the corp pres yesterday. This is between family and keep the tax stuff simple. We don't want to loose the 1202 stock over this one. Thank you for all your help and I do like Just Answers and will continue to send questions to you if okay. I know you will be gone this weekend but I think we have all the answers to this questions just need to work on the mechanics. The corp books and the sale are clean and simple, it is the family stuff that should have been worked out long before this and I think they understand the issue fairly well.

Thanks again

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