Closing a business involves many challenges, including complex tax considerations. Rising prices, labor shortages, and supply chain disruptions have pushed many businesses to shut their doors. Additionally, some owners choose to retire, prompting business closures. Here’s what C corporation owners need to know about the tax implications of a complete liquidation.
Tax Considerations for Long-Term Gains
The maximum federal income tax rate on long-term gains for individuals is currently 20%, with an additional 3.8% net investment income tax (NIIT) potentially applying. Despite political discussions, significant changes to these rates are unlikely before 2028.
Understanding Complete Liquidation
A complete liquidation occurs when:
The corporation ceases operations.
Debts are paid.
Remaining assets are distributed to shareholders.
While a written plan is not mandatory, it is highly recommended to document the process and distinguish between regular and liquidating distributions.
Liquidation can occur through:
Distribution of all assets to shareholders.
Selling assets and distributing proceeds.
A mix of asset sales and distributions.
Tax Implications of Liquidation
Corporate Level: A flat 21% federal tax rate applies to both capital gains and ordinary income. However, a corporation cannot deduct net capital losses.
Shareholder Level: Liquidation distributions are treated as exchanges for stock, with gains or losses based on the difference between the fair market value of assets received and the stock's adjusted basis.
Hypothetical Example
If a C corporation with appreciated assets liquidates, double taxation often occurs. Both corporate and shareholder levels are taxed. For example, a corporation with $3 million in appreciated land may face over $895,000 in combined taxes after liquidation. Planning ahead can help minimize this burden.
Planning for the Future
While current tax laws favor stability, political changes could impact rates after 2028. Stay informed and consult with a tax professional to explore strategies like reasonable compensation to mitigate double taxation.
Contact Verity CPAs at info@verity.cpa or 808.546.5026 for expert guidance on navigating business closures.
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