To the extent that a distribution is made from the corporation’s earnings and profits, it is taxed to the shareholder as a dividend. The portion of the distribution that is not considered a dividend is applied first to reduce the shareholder’s basis in the corporation’s stock. Any remaining portion is treated as gain from the sale or exchange of property (capital gain). Important Note: If a shareholder assumes a liability or takes property subject to a liability, the amount of the distribution is reduced by the amount of the liability. Special rules also apply at the corporate level. Special rules apply to distributions to a shareholder in exchange for the shareholder’s stock (redemptions).
Instead of being treated as dividends, redemptions are treated as a sale or exchange of the stock by the shareholder. The distinction can be important when the long-term capital gains rates (which apply to redemptions) are higher than the tax rates on dividends.
Corporate shareholders may prefer that the distribution be treated as a dividend, allowing the corporation to take advantage of the special dividends-received deduction under Code § 243 (which allows the dividends to only be taxed once at the corporate level).
On the other hand, individual shareholders often prefer that the distribution be treated as a redemption, for three reasons: A distribution qualifies as a stock redemption only if it significantly reduces the interest of the shareholder in the corporation.
WHETHER PLANNING FOR A LIQUIDATION of their own professional practices or advising clients about the liquidation of a commercial organization, CPAs will find that the problems and the solutions associated with each are likely to be the same.
awyers advise CPAs to have employment and noncompete agreements in their accounting practices.
THE QUESTION OF WHO "OWNS" the clients and customer-based intangibles turns on whether there is an employment or noncompete agreement in effect at the time the intangibles are distributed.
Liquidating distributions also has tax implications for the corporation that may need to be reported to the Internal Revenue Service on the company's final return.
If you own shares in a corporation that makes liquidating distributions to you, the IRS treats the transaction as a sale or exchange of your stock.
Forming a C corporation was once the only way the owner of a small business could shield himself from the debts and liabilities of the company.
Other forms of ownership, such as limited liability partnerships, have replaced the traditional C corporation structure for many small businesses.