Tax implications of liquidating a corporation
The United States Tax Court generally applies a three part test in determining whether there was a plan to liquidate: 1) Was there a manifest intent to liquidate; 2) Was there a continuing purpose to terminate corporate affairs and dissolve; and, 3) Were the corporate affairs confined and directed to the purpose of liquidation.
Substance over form will control the analysis of whether a corporation has completely liquidated, and the facts will control this analysis.
However, Federal Tax Regulations § 1.332-2(c) holds: A status of liquidation exists when the corporation ceases to be a going concern and its activities are merely for the purpose of winding up its affairs, paying its debts, and distributing any remaining balance to its shareholders.
Shareholders receive a benefit through the complete liquidation because under IRC § 331(a), the amounts received by the shareholders are considered full payment in exchange for their stock, and therefore the shareholder receives capital gain treatment as opposed to a dividend distribution.
As a capital gain, the shareholder is able to use their basis in the stock to offset or lower the capital gain.