Corporate liquidation tax reporting without the loose ends

A corporation doesn’t disappear just because the owners shut the doors. Miss Form 966, Corporate Dissolution or Liquidation, or empty the bank account before the tax bill lands, and the wind-down can become an expensive cleanup job for both the corporation and its shareholders. Read on to clarify some common corporate liquidation tax reporting sticky points.

Start the liquidation clock with Form 966

When is Form 966 required?

A corporation generally files Form 966 when it adopts a resolution or plan to dissolve or liquidate. An asset sale alone does not trigger the filing, but a formal decision to wind down the corporation may do so.

Form 966 is generally due within 30 days after the plan or resolution is adopted.

Must the Form 966 date match the final-return date?

No. Form 966 follows the plan-adoption date. The final corporate return generally covers a short tax year ending when the corporation has ceased business and completed the steps necessary to dissolve for federal tax purposes.

The dates may be different when assets remain, liabilities are unresolved or distributions continue after the plan is adopted.

That short-year return also needs a balance sheet that reflects the corporation’s true financial position at closing.

What should Schedule L show?

Schedule L (Form 1120), Balance Sheets per Books, should report the corporation’s actual ending balances. After all liquidating and closing entries, many corporations will have little or nothing left, but the schedule should not be blank if assets, liabilities or equity remain.

An LLC follows these rules only when it is classified as a C or S corporation for federal tax purposes. Verify the entity’s prior returns and elections before choosing the reporting path.

Report liquidating distributions on the right forms

How are liquidating distributions reported?

Report cash liquidating distributions in Box 9 of Form 1099-DIV, Dividends and Distributions. Report the fair market value (FMV) of noncash property in Box 10 without reducing it for liabilities assumed by the shareholder.

Normal Form 1099-DIV deadlines apply. The form is generally due to the shareholder by Jan. 31, to the IRS by Feb. 28 when filed on paper and by March 31 when filed electronically.

Routine S corporation distributions generally belong on Schedule K-1 (Form 1120-S), Shareholder’s Share of Income, Deductions, Credits, etc., and are tracked through stock basis and the accumulated adjustments account. Form 1099-DIV is used for liquidating distributions and may also apply when a distribution is treated as a dividend from prior C corporation earnings and profits.

How does the shareholder report the liquidation?

A liquidating distribution is generally treated as payment for the shareholder’s stock. An individual shareholder compares the cash and FMV of property received with the adjusted stock basis and reports the resulting gain or loss on Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D (Form 1040), Capital Gains and Losses.

The basis comparison only works if the property’s value is nailed down correctly before it ever leaves the corporation.

Value property before it leaves the corporation

How are in-kind property distributions treated?

The corporation generally recognizes gain or loss as though it sold the property for FMV. The shareholder’s basis in the property is generally its FMV when distributed.

How should FMV be determined?

Use support appropriate for the asset. An appraisal may be appropriate for significant property, while comparable sales or documented market data may support other assets. Book value alone isn’t usually enough.

Liabilities attached to the property add another layer to the calculation, for both the corporation and the shareholder.

How are liabilities handled?

For the corporation, gain is generally measured using the greater of the property’s FMV or the attached liability. For the shareholder, an assumed liability generally reduces the amount realized for the stock.

What if the corporation cannot pay the tax?

The tax is still due. Distributing appreciated property can create taxable gain without producing cash. Calculate the tax before distributing assets and retain enough funds to pay it.

Keep filing until the corporation is truly closed

Can an S corporation distribute an installment note and close?

Yes, if the special installment-sale rules for complete corporate liquidations apply. The note must be distributed under a complete liquidation plan, and the liquidation generally must be completed within 12 months. Related-party and other exceptions may limit the treatment.

Can the corporation stay open to collect installment payments?

Yes. The corporation may remain open while collecting payments or winding up its affairs. It generally continues filing returns until the liquidation is complete and no assets or liabilities remain.

Before filing the final return, confirm that the corporation has finished winding up and can pay its remaining tax. Shareholders should also receive the information needed to report what they received.

 

Discover more in the Oct. 1 Tax Implications for Liquidating a Corporation webinar, also available on demand!