Liquidating vs nonliquidating distributions
Liquidating distributions are not governed by the normal S corporation distribution rules.
Instead, liquidation of an S corporation is governed by the same rules that apply to liquidation of a C corporation.
While there are differences, the S corporation basis system is similar to the rules that apply to partnerships.
The tax consequences of distributions by an S corporation to a shareholder depend on the shareholder’s basis in the S corporation stock.
Like C corporations, S corporations recognize no gain or loss on a distribution of cash to its shareholders.
If the S corporation distributes appreciated property to a shareholder, the corporation must recognize gain as if the property were sold to the shareholder at fair market value.
The IRS mandates in section 331(a) of the IRS Tax code that distributions of 0 or more must be reported on Form 1099-DIV.
The shareholder will also have two tax consequences from the liquidation.
This means that the normal distribution rules of Section 1368 do not apply to liquidating distributions.
Because the income of S corporations is taxed to the owners when the income is earned, a mechanism is needed to ensure that the shareholder is not taxed again when the earnings are distributed.
This is done through a system of rules that track and adjust the shareholder’s stock basis.