Liquidating vs nonliquidating distributions parnterships
Because the income of S corporations is taxed to the owners when the income is earned, a mechanism is needed to ensure that the shareholder is not taxed again when the earnings are distributed.
This is done through a system of rules that track and adjust the shareholder’s stock basis.
By contrast, liquidating distributions are treated as though the shareholder had sold her S corporation stock to the S corporation in exchange for the distribution from the S corporation. Note: Since the ordinary distribution rules do not apply, the S corporation’s accumulated earnings and profits or accumulated adjustments accounts do not determine the character of the distribution.
The shareholder will also have tax consequences from the liquidation.
First, if the corporation distributes appreciated or depreciated assets as art of the liquidation, the S corporation’s gain or loss from the deemed sale of assets is passed through to the shareholder, The shareholder will also be taxed on the liquidation itself.
The amount that a shareholder receives in a liquidating distribution is treated as full payment in exchange for the shareholder’s S corporation stock.
In other words, if the S corporation is making a liquidating distribution, the shareholder is treated as having sold her stock for the amount of the distribution.