When a corporation goes through a liquidation, its shareholders end up with their individual shares of the company's value. Shareholders stand in line behind creditors when a company goes out of business and then you may be liable for some capital gains taxes on the value received.
Exchange of Shares
Under the tax rules -- Section 331 covers the topic -- with the liquidation of a corporations, shareholders exchange their shares for the cash or asset received. This means the liquidation value will be treated as a sale of the stock rather than as a dividend received. As a result of these rules, the transaction will be reported as a capital gain or loss on your tax return.
Last in Line
Shareholders are last in line to get paid when a company is liquidated. Creditors, including bank loans, bonds for a larger corporation and accounts payable, must be paid first out of the liquidated assets. If a company has issued preferred shares, those shareholders have a higher claim on the assets than do the regular, or common shareholders. If the corporation is being liquidated as the result of a lack of financial success, there may be little in the way of assets left for the shareholders. On the other hand, it is very possible that a smaller, closely held corporation may be shut down for other reasons, with plenty of value for the shareholders to split up.
Cash or Assets
The simple form of liquidation occurs when all of the company assets are sold and converted to cash. The cash is then distributed to shareholders proportionately in exchange for the number of shares each investor owns. The other option for liquidation is to distribute assets such as real property or equipment to shareholders as part of the liquidation. If this occurs, the value of the assets you receive is the current fair market value for tax purposes. That value could be higher or lower than what the corporation paid for the assets. The shareholder may then have another reportable gain or loss when the assets are sold.
Cost Basis Valuation
Whether you have a gain or loss on your tax return depends on the value received for your shares compared to your cost basis in the shares. If a C corporation is liquidated, the cost basis will be the price you initially paid for the shares. For a S corporation liquidation, your cost basis changes with dividends paid out to you and any capital you paid into the company. The accountant for the corporations should provide you with your current basis. If you cannot show proof of cost basis, the tax rules assume your basis is zero and all distributions you receive from the liquidation will be taxable capital gains.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.