Running head: LIQUIDATION AND DISSOLUTION 1

Liquidation and Dissolution of a Corporation

John Simpson
Professor Michelle Slabiak
Strayer University
Advanced Federal Taxation
July 22, 2012







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Liquidation and Dissolution of a Corporation
The process of dissolving or liquidating a corporation can be as complicated as the
forming of a corporation. The formation of a corporation includes the exchange of property and
money, acquiring shareholders, and most importantly, setting up the statement of incorporation.
When you dissolve or liquidate a corporation, you reverse the actions. No matter which one you
do, they both involve entities outside the business itself, such as paying suppliers and vendors,
notifying the IRS of the liquidation, and stock return from shareholders of the corporation.
Dissolving a corporation certainly has its own rules, regulations and requirements and to
understand the processes necessary to liquidate, it is important to have an understanding of how
the formation happens.
In order to form a corporation, there are eight requirements that have to be met. First
you need to choose a business name that complies with your states corporation rules then you
need to appoint the initial directors of your corporation. Next you need to file formal paperwork,
which is usually referred to as articles of incorporation and then you need to create corporate
bylaws, which lay out the operating rules for your corporation. Next you should create a
shareholders agreement. Then you need to hold the first meeting of the board of directors.
Issuing of stock certificates to the shareholders of the company is the next thing and finally you
need to obtain any licenses and permits that are mandatory for your business (Edmund, 2012).
As the corporation becomes successful, the shareholders will earn dividends throughout
the year and the corporation will grow. As the shareholders earn more money, there is also an
increase in property value and the size of the organization will increase. However, not all
corporations are successful and sometimes fail to maintain the going concern. When
corporations lose the going concern whether it is due to the loss of business demand or the
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inability to maintain market share or the shareholders decide to leave the corporation, the result
can be liquidation. Thus, when a corporation does not become self-sustaining it ends up having
to dissolve or liquidate the corporation all together.
According to the Internal Revenue Service, dissolution of a corporation is the complete
closure of a business. Dissolution of a business is either voluntary or involuntary. The voluntary
dissolution of a business can be achieved by the board of directors or by an agreement of all the
shareholders, or both. An involuntary dissolution for example is the result of the corporation
failing to pay its taxes or when creditors petition to the court for its dissolution (IRS Manual,
2012, p.1).
Once a corporation has been marked for dissolution, a form of liquidation of assets is
required. In this case, a complete liquidation is in order. Corporation liquidation exists when a
corporation ceases to be a going concern. The corporation continues solely to wind up affairs,
pay debts and distribute remaining assets to its shareholders. Legal dissolution under state law is
not required for a liquidation to be complete for tax purpose (Hoffman, W. H., Mahoney, D.M.,
Raabe, W.A., Young, J. C., 2012). Winding down affairs involves closing the business,
completing final taxation, payroll, and distribution of properties. Once a corporation finally
decides on a complete liquidation, it takes some time to actually cease to exist.
When considering corporate liquidation it is important for the corporation to clearly
define what that liquidation entails. According to the IRS Manual 4.11.7 Corporate
Liquidations/Dissolutions, some corporations can adopt plans of liquidation which appear on the
surface to meet the various statutory requirements for liquidations when the substance of these
transactions is analyzed, however, the liquidations may actually be corporate reorganizations or
other schemes which have been devised for the purpose of tax avoidance (2012, p.2).
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Reorganization has a tax free advantage and a lot of struggling businesses may take this course to
try and take advantage of a tax break. According to Hoffman (2012), shareholders also may
decide to liquidate for one or more reason if the corporation business has been unsuccessful or
the shareholders wish to acquire the corporations assets.
It is important that if a complete dissolution is taking place, the corporation must pay all
the shareholders and all outstanding shares of stocks are recalled and all income distribution
should be provided to all that are involved with the company. According to the IRS 4.11.7
Corporate Liquidations/Dissolutions, dividend income does not apply at the liquidating
distribution; rather all distributions are treated as sales and exchange (2012). If the organization
liquidates in order to reorganize, then an exchange or sale is taking place and assets have a
different treatment. E&P has no impact on the gain or loss that is recognized by the
shareholderHowever, liquidation process has a different tax consequence on the distributing
corporation (Hoffman et al., 2012). It is important for corporations to make sure not to disguise
as reorganize under liquidation because as mentioned earlier, the IRS considers this as tax
avoidance with severe ramifications.
Once liquidation is underway, the primary goal is to liquidate all assets. Assets include
property, land, and stocks. As the assets are sold or exchanged, the shareholder recognizes gains
and/or losses. If there is a gain, the shareholder gain is not to exceed the basis in the asset. In
the case of complete liquidation rule 331(a) it provides for sale or exchange treatment for the
shareholders. Thus, the difference between the fair market value of property received subject to
a corporate liability is reduced by the amount of such a liability (Hoffman et al., 2012).
Basically, the shareholders are turning their capital assets back to the corporation and, in turn the
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shareholders are able to recognize a capital gain or loss from this distribution based on fair
market value.
A liquidation or dissolution is considered on two levels, the shareholders level and the
corporate level, and there are definitive guidelines about which losses can be claimed and which
cannot. When a corporation liquidates, it generally can claim losses on assets that have
depreciated in value. These assets should not be distributed in the form of stock redemption or
property dividend because losses are not recognized on non-liquidating distribution (Hoffman et
al., 2012). It is also important during a distribution of capital for the corporation not to recognize
a loss on disqualified properties; which are any properties acquired within five years of the
distributions. The rules allow for both the shareholder and the corporation to base their losses, or
gains, in fair market value. On the shareholders level, this may center on capital and
investment. On the corporate level, this may reflect property dividends or stock redemption. For
example, if a parent company is liquidating its subsidiary or child company, No gain or loss is
recognized to the parents. Subsidiary must distribute all of its property within the taxable year or
within three years from the close of the taxable year in which the first distribution occurs.
(Hoffman et al., 2012). The implications of this are reflected on the corporate level.
Whether a business is dissolving or liquidating, the shareholders as well as the
corporation itself must pay close attention to the requirement and guidelines set forth by the
Internal Revenue Service. It is important that all parties that are involved in dissolution or
liquidation understand the tax consequences of this distribution attained. While a great deal of
energy goes into ensure that all rules and requirement, it is necessary in order to avoid tax
consequences. These rules are also in place to ensure that equal distribution of assets goes to
both the corporation and the shareholders based on an established fair market value.
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Reference Page
Edmund, J. (2012, July 28). Corporate Structure 8 steps to forming a corporation. Retrieved
from Asset Protection Worldwide: www.assetprotectionworldwide.com/corporate-
structures/8-steps-to-forming-a-corporation-in-the-united-states.
Hoffman, W. H., Mahoney, D.M., Raabe, W.A., Young, J. C., (2012) South-Western Federal
Taxation 2012. Ohio. Cengage
Internal Revenue Manual-4.11.7 Corporate Liquidations/Dissolutions. Retrieved July 28, 2012
from http://www.irs.gov/irm/part4/irm_04-011-007.html
Internal Revenue Manual - Dividends and Other Distributions. Retrieved Jul 28, 2012 from
http://www.irs.gov/publications/p17/ch08.html