Liquidating vs nonliquidating distributions

Distributions to investors up to their cost basis—the amount invested, including commissions and fees—in the stock is considered a non-taxable return of principal.

Amounts above investors' cost basis are reported as capital gains, a taxable distribution.

By contrast, liquidating distributions are treated as though the shareholder had sold her S corporation stock to the S corporation in exchange for the distribution from the S corporation. Note: Since the ordinary distribution rules do not apply, the S corporation’s accumulated earnings and profits or accumulated adjustments accounts do not determine the character of the distribution.

S corporations with accumulated earnings and profits should take advantage of this distinction by clearly identifying liquidating distributions in the documents authorizing the liquidation.

In contrast, distributions of appreciated property by C corporations and S corporations are treated as though the property were sold to the shareholder at fair market value.Distributions to the shareholder are not included in the shareholder’s gross income if the distribution does not exceed the shareholder’s basis in the stock.Because the tax consequences of distributions depend on the shareholder’s basis, it is important to keep up with changes in the shareholder’s basis over time.Proceeds from a cash liquidation distribution can be either a non-taxable return of principal or a taxable distribution, depending upon whether or not the amount is more than the investors' cost basis in the stock.The proceeds can be paid in a lump sum or through a series of installments.

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