Unlocking Tax Benefits: A Guide to Shutting Down a C Corporation

If you run your business as a C corporation and are ready to shut it down, you probably face the federal income tax issues that arise from a complete corporate liquidation.

This article explains the basic tax results for the corporation and its shareholder(s), like you.

“Complete Liquidation” De?ned

For federal income tax purposes, a complete liquidation occurs when the corporation

• Ceases to be a going concern,
• Winds up its affairs and pays its debts, and
• Distributes its remaining assets to the shareholder(s).

For federal income tax purposes, distributions to shareholders in complete liquidation of a corporation mean one or more distributions in redemption of all the corporation?s stock pursuant to a plan.

While you don?t need a formal written plan for distributions in complete liquidation, we strongly recommend having one because it:

• Fixes the date that the liquidation process begins,
• Creates a dividing line between regular dividend distributions (if any) and liquidating distributions, and
• Shows (for liquidations that take more than one tax year to complete) when a series of liquidating
• distributions begins and ends.

Complete Corporate Liquidation Basics

You can accomplish a complete liquidation of a C corporation in three basic ways:

• All of the corporation’s assets can be distributed in complete liquidation to the shareholder(s).
• The corporation can sell all of its assets and then distribute the sales proceeds to the shareholder(s) in complete liquidation.
• The corporation can sell some assets and distribute the resulting sales proceeds along with the
• remaining unsold assets to the shareholder(s) in complete liquidation.

All three alternatives usually result in about the same bottom-line federal income tax results for both the corporation and the shareholder(s). Here are the details.

Corporate-Level Tax Results from Actual Asset Sales Followed by Liquidation

Your C corporation might sell some or all of its assets and distribute the resulting cash to you and any other shareholders as part of a complete liquidation. This can be accomplished with one or several liquidating distributions.

Depreciable property or business real property held for more than one year is so-called Section 1231 property. If your corporation?s sales of Section 1231 property result in an overall tax loss, you generally treat the loss as a fully deductible ordinary loss.

If sales of Section 1231 property result in an overall tax gain, you generally treat the gain as a long-term capital gain.

But you treat gain attributable to depreciation or amortization of Section 1231 property as ordinary income rather than capital gain.

Report the corporate-level deemed sales of distributed assets just as you would for actual sales. So, report deemed sales of most business assets on IRS Form 4797, Sales of Business Property.

Key Point:?For a C corporation, the federal income tax distinction between capital gain and ordinary income is usually not meaningful because the ?at 21 percent corporate tax rate applies to both.

But in the relatively unusual situation where a C corporation has non-business capital assets, such as stock or mutual fund shares held for investment, the distinction can be important because a C corporation cannot deduct a net capital loss. Capital losses can only be used to offset capital gains.

Corporate-Level Tax Results from Deemed Asset Sales When Assets Are Distributed to Shareholders in Complete Liquidation

If your corporation distributes property other than cash to you and any other shareholders in complete liquidation, the corporation must recognize taxable gain or loss as if the distributed property had been sold to you and any other shareholders for fair market value (FMV).

Once again, both depreciable property and business real property held for more than one year are so-called Section 1231 property. Treat deemed gains and losses upon liquidation in the fashion explained earlier.

Report the corporate-level deemed sales of distributed assets just as you would for actual sales. So, report deemed sales of most business assets on IRS Form 4797 (Sales of Business Property).

Key Point:?Once again, for a C corporation, the federal income tax distinction between capital gain and ordinary income is usually not meaningful, as explained earlier.

Shareholder-Level Tax Results

For federal income tax purposes, treat a liquidating corporate distribution at the shareholder level as payment in exchange for your stock.6 You as a shareholder must generally recognize taxable gain or loss equal to the difference between the FMV of the assets received (whether cash, other property, or both) and the adjusted basis of the stock that you surrender in the deal.

When the stock is a capital asset in your hands (which it almost certainly will be), the liquidating distribution will trigger a taxable capital gain or loss.

Your tax basis in any non-cash distributed property received in the complete liquidation is the property?s FMV at the time of distribution.

Summary of Combined Tax Results for You and Your Corporation

The impact of the aforementioned rules is as follows:

1. If the corporation sells all of its assets and distributes the resulting sales proceeds as cash, the taxation process for a recipient shareholder (that would be you) is complete when you recognize taxable capital gain or loss upon receiving the cash.
2. If you receive multiple liquidating cash distributions, you are allowed to recover all the tax basis of your stock before recognizing any taxable gain. After you’ve recovered all of your basis, treat 100 percent of any subsequent distributions as taxable gain.
3. If you receive non-cash assets in the liquidation, the initial tax basis of the assets generally equals their FMV as of the distribution date. Recognize taxable capital gain or loss equal to the difference between the FMV of the assets received (including any cash) and your tax basis in the stock that you surrender in the complete liquidation.

Key Point:?The complete liquidation of a C corporation with appreciated assets will often result in double taxation— once at the corporate level and again at your shareholder level.

Is Time of the Essence?

Maybe. The current maximum individual federal income tax rate on long-term gains from a 2023 corporate liquidation is “only” 20 percent, or 23.8 percent if you also owe the 3.8 percent net investment income tax (NIIT).

The tax hit on a liquidation taking place in a later year could be signi?cantly higher if the current favorable federal income tax rate regime goes away. As things currently stand, the favorable Tax Cuts and Jobs Act (TCJA) individual rate regime is scheduled to expire after 2025. The current ?at 21 percent corporate federal income tax rate is supposed to be permanent, but nothing is permanent with politicians on the loose.

Example: Liquidating a C Corporation with Appreciated Assets

Sea Corporation liquidates by distributing its assets to its two equal shareholders, Bob and Irene. The company owns two assets: (1) a tract of undeveloped land with an FMV of $3 million and a tax basis of $1.5 million, and (2) $1.255 million in cash.

Bob and Irene each have tax basis of $750,000 in their Sea Corporation stock, which they have owned for years.

Sea Corporation recognizes a $1.5 million corporate-level taxable gain on the liquidating distribution of the land ($3 million FMV versus $1.5 million basis) because the land is deemed to be sold for FMV in the liquidation.

Assume the corporate-level federal income tax hit is $315,000 (21 percent x $1.5 million gain from the deemed sale of the land). We will ignore any state income tax hit.

Sea Corporation pays the $315,000 tax bill and distributes the remaining $940,000 cash ($1,255,000 – $315,000), resulting in $470,000 to each shareholder. Each shareholder also receives a 50 percent interest in the land.

For federal income tax purposes, each shareholder receives a liquidating distribution of $1.97 million ($470,000 cash plus land with FMV of $1,500,000) in exchange for their Sea Corporation stock. The exchanges are treated as stock sales.

Therefore, each shareholder recognizes a long-term capital gain of $1.22 million (liquidation proceeds of $1,970,000 minus stock basis of $750,000). If the gains are taxed at the 20 percent maximum federal rate and the 3.8 percent NIIT is also owed, the tax hit is $290,360 for each shareholder (23.8 percent x $1,220,000).

Bottom Line:?The corporate-level and shareholder-level federal income tax bills add up to $895,720 [$315,000 + (2 x $290,360)], which is painful enough. But if tax rates go up, liquidating in a later year, the tax hit could be higher. In any case, liquidating right now will trigger current income tax bills, while liquidating in a later year will defer the tax bills.

Planning Point:?Depending on the circumstances, it may be possible for Bob and Irene to take some cash out of the corporation in the form of deductible salary or bonus payments. Such payments would reduce the amount that is subject to double taxation, but the payments would be taxed at ordinary rates and be subject to Social Security and Medicare taxes.

Takeaways

You now understand the basic federal income tax implications of a complete corporate liquidation at today?s tax rates.

The current, more favorable TCJA individual tax rates are scheduled to sunset after 2025. They could go away sooner depending on political developments, but they will probably last through at least 2024. Fingers crossed!

That said, waiting to liquidate could result in a bigger tax bill. Balance that risks against the fact that a 2023 liquidation can trigger current tax liabilities versus deferred tax liabilities with a future-year liquidation.

Corporate Liquidation Checklist

A written plan of complete corporate liquidation should be adopted by the board of directors.

The corporation must ?le Form 966 (Corporate Dissolution or Liquidation) within 30 days after the adoption of the plan of liquidation.

Attach a certi?ed copy of the plan of liquidation to Form 966.

The corporation should ?le its ?nal tax return. The due date of the ?nal federal income tax return for a C corporation that completely liquidates before its normal tax year-end is the 15th day of the fourth full month following the liquidation date.

For example, if a calendar-year C corporation completely liquidates on September 30, 2023, the due date for the ?nal Form 1120 (without extensions) is January 15, 2024.

The corporation should consider hiring a professional appraiser to determine the FMV of any signi?cant non-cash assets that will be distributed in complete liquidation. The FMV of the distributed assets decides the tax consequences for both the corporation and its shareholder(s).

Remember that for federal income tax purposes, the corporate-level gains and losses resulting from the deemed sale of assets distributed to shareholders in complete liquidation should be reported as if the assets were actually sold.

If the corporation sells assets that comprise a business in conjunction with the liquidation, it may be necessary to ?le Form 8594 (Asset Acquisition Statement Under Section 1060).

The corporation must complete Form 1099-DIV (Dividends and Distributions) for each person to whom it makes liquidating distributions (cash or property) of $600 or more in any one tax year. A copy of Form 1099-DIV must be provided to the shareholder, and the original must be provided to the IRS.

Legal title to non-cash assets distributed to a shareholder in complete liquidation should be changed to the recipient shareholder?s name.

Hopefully, you have gained some insights into the complexities of shutting down your C corporation. If you find yourself needing expert guidance to navigate the complexities of crucial tax obligations and optimize your financial benefits and ensure a seamless transition look no further than Morris + D’Angelo.

At Morris + D’Angelo, we specialize in providing expert financial guidance and assistance to business owners like you. If you have questions or concerns about how you might navigate the complexities with expert insights and actionable strategies for optimizing your C corporation closure, our expert team is here to help.

Don’t let complex tax laws hold you back – contact us at Morris + D’Angelo to learn how we can support your financial success! This is our Expertise!

Parts of this article are published with permission from?Bradford Tax Institute , ? 2021 Daniel Morris, Morris + D’Angelo

Daniel Morris

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