When a corporation liquidates, it distributes all its assets to its shareholders in exchange for their stock. The shareholders recognize gain or loss as if they sold their stock. § 331(a). The corporation recognizes gain or loss as if it sold its assets to the shareholders. § 336(a).
The shareholder’s gain or loss is the difference between the fair market value of the assets received (minus liabilities assumed) and his basis in his stock. The character of the gain or loss is capital (unless the shareholder is a dealer). The shareholder’s basis in the assets received is their fair market value. § 334(a).
The corporation’s gain or loss is the difference between the fair market value of the assets distributed and the corporation’s basis in those assets. If the corporation distributes property subject to a liability, the fair market value is treated as not less than the liability. § 336(b). This prevents the corporation from avoiding gain by distributing property worth less than the debt.
But there are limitations. Under § 336(d)(1), the corporation cannot recognize loss on distributions to related parties (as defined in § 267) if the distribution is not pro rata or if the property was acquired in a § 351 transaction within five years. Section 336(d)(2) requires the corporation to reduce the basis of loss property to its fair market value if the property was acquired in a § 351 transaction as part of a plan to recognize loss on liquidation.
The Norwalk case, T.C. Memo 1998‑279, shows how hard it can be to value intangible assets like goodwill in a liquidation. The Tax Court held that because there were no covenants not to compete, the goodwill belonged to the individual accountants, not the corporation. So the corporation had no taxable gain on the liquidation. The lesson: if you want the corporation to own goodwill, have employees sign non‑compete agreements.
This article is for general informational purposes only and is subject to change. Tax laws are complex and vary by situation. You should consult a qualified professional for advice specific to your circumstances. For questions, contact Alan Goldstein.
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