To the extent that a distribution is made from the corporation’s earnings and profits, it is taxed to the shareholder as a dividend. The portion of the distribution that is not considered a dividend is applied first to reduce the shareholder’s basis in the corporation’s stock. Any remaining portion is treated as gain from the sale or exchange of property (capital gain). Important Note: If a shareholder assumes a liability or takes property subject to a liability, the amount of the distribution is reduced by the amount of the liability. Special rules also apply at the corporate level. Special rules apply to distributions to a shareholder in exchange for the shareholder’s stock (redemptions).Instead of being treated as dividends, redemptions are treated as a sale or exchange of the stock by the shareholder. The distinction can be important when the long-term capital gains rates (which apply to redemptions) are higher than the tax rates on dividends.331 for the difference between the FMV and the shareholder’s basis in the stock).As a result, the tax consequences of a subsequent sale of the assets by the shareholder should be minimal. The corporation is treated as selling the distributed assets for FMV to its shareholders, with the resulting corporate-level tax consequences.
If the corporation distributes appreciated property, the corporation is taxed on the gain under Code § 311(b).
Trade secrets, special processes, patents and proprietary information are among an employer’s protectable interests, but how noncompete provisions create an employer property right isn’t clear.
THE PRACTITIONER SHOULD ADVISE the client to terminate employment and noncompete agreements with shareholders before liquidation.
Corporate shareholders may prefer that the distribution be treated as a dividend, allowing the corporation to take advantage of the special dividends-received deduction under Code § 243 (which allows the dividends to only be taxed once at the corporate level).
On the other hand, individual shareholders often prefer that the distribution be treated as a redemption, for three reasons: A distribution qualifies as a stock redemption only if it significantly reduces the interest of the shareholder in the corporation.
So what happens if a corporation (C Corp or S Corp) distributes property or stock other than cash to a departing shareholder?