Tax treatment of liquidating distribution
1244 stock, the shareholder may be able to claim an ordinary loss rather than a capital loss. Since the existence of AE&P has no impact on the characterization of a liquidating distribution, an S corporation with AE&P should identify liquidating distributions as such (for example, in a board of directors resolution adopting the plan of complete liquidation).Distributions in complete liquidation of an S corporation are treated as payments in exchange for the shareholder’s surrendered stock (Sec. In addition, during the liquidation of an S corporation, it may be difficult to predict the ending balance of AAA.This may in turn make it difficult to accurately determine the AAA available for ordinary distributions and makes inadvertent dividend distributions from AE&P more likely to occur.he shareholder consequences of a complete liquidation of an S corporation are governed by Secs. The dividend rules that otherwise apply to corporate distributions are not applicable to distributions in complete liquidation.Distributions received by the shareholder are treated as payment in full for the exchange of stock. The shareholder recognizes gain when the adjusted basis of each block has been recovered, while loss is not recognized until the corporation has made its final distribution.recognizes no gain or loss on Block 2 (,000 – ,000 basis) and has a remaining basis of ,000 in Block 2.The 2008 distribution is allocated ,000 to Block 1 (10 ÷ 30 × 5,000) and ,000 to Block 2 (20 ÷ 30 × 5,000).
Long-term or short-term classification of a liquidation that qualifies for capital gain treatment depends on the shareholder’s holding period, with long-term status having significant importance due to the 15% tax rate cap on long-term capital gains.
Shareholders in the 35% tax bracket achieve a 57.1% ((35% – 15%) ÷ 35%) tax savings on capital gain versus ordinary income.