Cash Liquidation Distribution

What is Liquidation?

Liquidating a business is the process by which business comes to an end and no longer exists. This can happen for several reasons and can be voluntary or involuntary. The process involves appointing a liquidator, collecting business assets, paying creditors, resolving problems, and distributing the remaining funds to shareholders.

Benefits of Liquidation

While businesses may be forced to liquidate in case of insolvency, liquidating a healthy and solid business has practical advantages. These benefits range from high tax benefits (in some circumstances) to reduced compliance costs and the ability to distribute goods in their current form (in specie).

What Is a Cash Liquidation Distribution?

A cash liquidation distribution, also known as a liquidation dividend, is the amount of capital that is returned to the investor or the owner of the company when a company is partially or fully liquidated. When a company closes, and its assets are liquidated, the company issues cashless cash distributions, liquidation distributions, or both.

Distributions are returned to investors based on the company's capital structure. If money remains after the bondholders have been paid, the shareholders will receive part of the money. Distributions to investors based on their costs - the amount invested, including commissions and fees - in stocks are considered a non-taxable return on capital.

Amounts greater than the investor's costs are recorded as capital gains, a taxable distribution. Amounts lower than the investor's costs are recorded as capital losses. Credit unions also send this type of distribution to their depositors upon liquidation.

Understanding Cash Liquidation Distribution

The profits from a cash liquidation distribution can be a non-taxable statement of capital or a taxable distribution, depending on whether the amount is higher or lower than the cost of the investor's shares. The proceeds can be paid in a fixed amount or several instalments.

Often, income from cash liquidation distributions is presented in the Form 1099-DIV. The IRS requires in section 331 (a) of the IRS tax code that distributions of $ 600 or more must be declared on Form 1099-DIV. Any taxable amount received by the investor is indicated in Schedule D, the statement of capital gains and losses which is filed on the IRS 1040 form when declaring annual income.

Payments greater than the total investment are capital gains, subject to capital gains tax. If the amount received by the investor is less than the initial cost invested in shares, the investor can declare a capital loss, which reduces his tax bill. This loss can only be reported when the company issues a final liquidation distribution.

The length of the holding period determines whether the gains are classified as short-term or long-term gains.

Example of a Cash Liquidation Distribution

EFG Corporation is liquidated. John and Ryan are shareholders. John's base cost for his shares in EFG Corp. is $50. When receiving a cash payment of $75, $50 is the return of capital and is not taxable, while $ 25 is the profit and is taxable. Ryan has an initial cost of $ 100. When he receives his payment of $75, it does not cover the initial cost in stock. Ryan, therefore, has a loss of $ 25.