However, only the amount of distribution that is in excess of the recipient's original investment is taxable. The primary difference between C corporations and S corporations is that C corporations are taxed twice on earned income: : once at the corporate level when the income is earned, and again at the shareholder level when the income is distributed.

tax treatment of liquidating distribution-49

The amount of capital that is returned to the investor or business owner when a business is liquidated.

Cash liquidation distributions are usually considered a nontaxable return of principal.

Credit unions send this sort of distribution to their depositors when they are liquidated as well.

Proceeds from cash liquidation distributions are reported on Form 1099-DIV.

Instead of being treated as dividends, redemptions are treated as a sale or exchange of the stock by the shareholder.[6] 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.

The Internal Revenue Code uses four tests to make this distinction: To prevent gamesmanship among related parties, Congress has added another layer of rules that must be analyzed to determine if a distribution is a redemption.

These attribution rules provide that shares owned by a shareholder’s parents, children, and grandchildren (but not siblings) are considered to be owned by the shareholder.[11] Similarly, shares held by corporations, trusts, and partnerships are deemed to be owned by their shareholders beneficiaries, and partners, and vice versa.[12] As a result, shares held by these family members and entities are considered to be owned by the shareholder for purposes of determining whether the distribution qualifies as a redemption.