Disastrous Tax Consequences to Avoid When Liquidating an S Corporation

An S corporation is a small business corporation that can be advantageous for small businesses because the business itself is not subject to federal taxation, only the shareholders are. When an S corporation liquidates, the tax consequences for the corporation and its sole shareholder depend on the fair market values and basis of its assets. If the shareholder’s stock basis is large enough, the corporation can liquidate without incurring tax liability. When a corporation distributes its assets to shareholders, if the shareholder’s stock basis is more than $0, there will be a capital loss which can offset any capital gains. Distributing cash reduces the stock basis, so it’s best for the corporation to pay off debts with cash before distributing it to shareholders. If the corporation distributes a warehouse, any gain recognized will be taxed as ordinary income if the shareholder owns more than 50% of the corporation. When a person receives a piece of real estate as part of a distribution, they might have to pay taxes on any gain they make from selling it. The IRS has rules about how this gain is taxed, and trying to avoid paying taxes by manipulating the system can have consequences.

If a person receives a promissory note (a promise to pay a certain amount of money) in a distribution, they might have to pay taxes on any gain from selling it. However, there are ways to postpone paying these taxes in certain situations. If a company gives a shareholder a note in a complete liquidation, the shareholder won’t owe taxes on it until they actually get paid. But if the shareholder gets the note in a liquidation within 12 months of the company planning to close, they have to allocate their stock basis among all the assets they get, including the note. If the shareholder has enough stock basis, they won’t owe taxes in a liquidation. If the company gives the note in a nonliquidating distribution, any gain or loss is considered from the sale of the property. The basis of the note is the face value minus the income that would be reported if the obligation was paid in full. If the corporation wants to close down and give its property to the shareholders, there are ways to do it to minimize the tax they have to pay. One way is to transfer the property to a new company and then give it to the shareholders. This can help reduce the tax that needs to be paid. If people contribute property to a corporation and in exchange receive stock in the corporation, and they own more than 80 percent of the voting power and shares of the corporation, then no one has to pay taxes on the exchange. In our case, the corporation will give its warehouse to LLC, Inc. in exchange for stock in LLC, Inc. The corporation will own all of LLC, Inc. After the exchange, the basis (or value) of the property will be the same, with some adjustments for money or other property received. When a corporation contributes a warehouse to a limited liability company (LLC) in exchange for stock, the LLC’s stock basis will be the value of the warehouse minus any other property received, plus any dividends and gains recognized. This can help avoid certain tax consequences.

In another plan, the corporation will contribute a note to a newly formed LLC, and elect to have the LLC treated as a C corporation to take advantage of certain tax rules.

These plans help the corporation and its shareholders avoid paying extra taxes when transferring assets. Plan Three involves forming a new company (LLC3) and having it be treated as a C corporation for a short time. The current corporation will then transfer all its assets to LLC3, and LLC3 will become an S corporation. This will allow the current corporation to be liquidated without any tax consequences. When a corporation becomes a QSUB, it basically becomes part of LLC3, Inc. for tax purposes. This means that the QSUB doesn’t have to file its own taxes anymore, and its assets and debts become LLC3, Inc.’s. When the QSUB liquidates, LLC3, Inc. doesn’t have to pay taxes on any gains or losses from the liquidation, as long as it owns at least 80% of the QSUB’s stock. When a corporation completely cancels or redeems all its stock and distributes its assets, it may not have to pay taxes on any gains from the distribution. This also applies if the distribution is part of a plan to close down the corporation within three years. Additionally, if a corporation owned at least 80% of the stock and voting power of another corporation, it won’t have to pay taxes on any gains from distributing assets during the liquidation. When planning to close a business, it’s important to be aware of tax laws and how they may affect the company. If a company used to be a different type of corporation before becoming an S corporation, there are specific rules to follow when closing it. By understanding these rules and planning ahead, you can minimize the taxes your company and the people receiving its assets will have to pay. David Fall, an attorney with experience in business and tax law, wrote this article to help people understand the complexities of closing an S corporation.

Source: https://www.floridabar.org/the-florida-bar-journal/disastrous-tax-consequences-to-avoid-when-liquidating-an-s-corporation/