Corporate Liquidations under IRC § 331–§ 336

Ending a corporation’s life triggers taxable events for both the entity and its shareholders, yet specific code sections soften or eliminate the tax when asset and stock ownership relationships meet strict thresholds.

Section 331 treats non-parent shareholders as having sold their stock.

Gain or loss equals the difference between cash or fair-market value of property received and each shareholder’s basis in the shares.

High-basis shareholders may harvest capital losses; low-basis investors face capital gains. Liquidating distributions follow Section 331 even when paid in installments—each installment uses fair value on the distribution date, demanding periodic valuation of non-cash assets such as real estate or patents.

Journal entry — shareholder books (stock basis $4 million, liquidation proceeds $10 million)

Dr Cash/Property $10 000 000

Cr Investment in Corporation $4 000 000

Cr Gain on Liquidation $6 000 000

Individual shareholders receive capital-gain treatment; corporate shareholders use this gain to offset capital losses carried forward under Section 1212(a).

Section 332 lets an 80-percent corporate parent liquidate a subsidiary tax-free.

The parent must own at least 80 percent of vote and value on the liquidation date and must receive all subsidiary property within a single taxable year.

No gain or loss is recognized by either the parent or the liquidating subsidiary on the distribution of assets, other than hot-asset recapture under Sections 1245 and 1250. The parent assumes the subsidiary’s basis in assets via Section 334(b)(1) and inherits its tax attributes—NOLs, credit carryforwards, E&P—as if the subsidiary merged.

Journal entry — parent books receiving appreciated inventory (FMV $12 m, basis $7 m)

Dr Inventory $7 000 000

Cr Investment in Subsidiary $7 000 000

No Section 331 gain is recognized; Section 336(a) gain inside the subsidiary is suppressed by Section 337, and deferred tax does not arise on the basis carryover.

Section 336 imposes corporate-level gain on liquidations outside Section 332.

Absent an 80-percent parent, the corporation recognizes gain or loss on each asset as if sold at fair value, then distributes after-tax proceeds to shareholders.

Asset character governs tax: ordinary income for inventory, Section 1231 gains for property used in a trade or business, and recapture on depreciable assets. The corporation may use remaining NOLs to shelter gain but loses unused carryforwards at dissolution.

Illustrative liquidation — C-corp with appreciated building

• Basis $5 million, FMV $15 million

• § 1250 recapture $4 million ordinary income

• Residual $6 million Section 1231 gain

Corporate tax: $4 m × 21 % + $6 m × 21 % = $2.1 million.

Distributions to shareholders then follow Section 331 rules, producing a second layer of tax.

Installment obligations and contingent liabilities complicate basis and timing.

A liquidating corporation may distribute its own installment notes to shareholders. Section 453(h) lets shareholders elect installment-sale reporting, yet corporate-level gain under Section 336 occurs immediately at face value. Contingent environmental liabilities travel with assets; GAAP requires recognition but tax follows economic performance under Section 461(h), generating deferred-tax assets.

State conformity and withholding obligations persist through final returns.

Many states piggyback on Section 331–§ 336 but impose additional clearance requirements: bulk-sales notifications, real-property transfer taxes, and final franchise-tax payments. Liquidations involving foreign shareholders may still demand FIRPTA withholding on U.S.-real-property interests, even when the corporate-level gain is suppressed under Section 332.

Financial-statement impact under ASC 360 and IFRS 5 precedes tax derecognition.

Upon board approval of a formal liquidation plan, assets classify as “held for sale,” triggering impairment tests and separate presentation. Deferred-tax balances tied to these assets remain until the legal entity dissolves, then reverse when the tax return removes the entity from the consolidated group.

ASC 740 requires recognition of any Section 336 tax immediately, while Section 332 dissolutions create no current tax but transfer deferred-tax balances to the parent.

Cash-flow planning aligns asset sales with estimated tax payments.

Section 336 gain accelerates federal tax due within liquidating corporation’s final short-period return. Transaction teams stagger asset closings so early-year sales fund later-year tax deposits, preventing interest and penalty charges under Section 6655.

Checklist for tax-efficient liquidation

1. Confirm ownership: Verify 80-percent threshold for Section 332 before triggering dissolutions or share redemptions.

2. Update asset basis schedules: Capture bonus-depreciation impacts that lower potential Section 336 gain.

3. Model E&P balances: Decide whether pre-liquidation dividends reduce double taxation versus distributing via liquidation.

4. Evaluate NOL usage: Accelerate income or asset sales to absorb losses before dissolution eliminates carryforwards.

5. Address state exit taxes: File certificate-of-dissolution forms and clear bulk-sales audits.

6. Document valuations: Keep third-party appraisals to support fair-market values assigned to distributed property.

   
   

Accurate ownership verification, early asset-basis reconciliation, and coordinated distribution timing allow corporations to liquidate entities while minimizing combined corporate and shareholder tax exposure.

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