The liquidation of an S corporation proceeds in a similar manner as the dissolution of a C corporation. The main difference occurs in the distribution of company assets to shareholders. Because an S corporation has restrictions on how many and what type of shareholders it can have, shareholders receiving assets usually have important roles within the business. Receiving company assets in a liquidation may have greater tax implications, depending on the value of those items.
Articles of Dissolution
The liquidation of a corporation, including an S corporation, requires the filing of documentation known as articles of dissolution with the appropriate secretary of state's office. This documentation declares the ending of the corporation's business endeavors and formally begins the company's liquidation process. According to certified public accountant and author Stephen L. Nelson, procedures and forms required for the dissolution of an S corporation can vary by state, though the actual dissolution paperwork is usually just a single form. If the business originally formed as a limited liability company or C corporation, additional dissolution paperwork may be necessary to formally dissolve the business.
Assets to Shareholders
The S corporation distributes assets at the time of liquidation to its shareholders. Since an S corporation doesn't issue common stock, shareholders are more likely to be founders of the company who originally incorporated the business. The corporation delivers assets to shareholders at fair market value. The Internal Revenue Service requires any shareholders receiving assets with depreciated values exceeding fair market to show a gain on federal income tax returns. For example, receiving company equipment with a value of $5,000 when the fair market value is $2,000 requires shareholders receiving this equipment record the $5,000 as income. This leads to higher tax liability.
Selling Corporate Assets
Selling corporate assets is an attractive alternative for shareholders during the liquidation of an S corporation. Money received from the sale can help pay the corporation's business debts and other financial obligations. Additionally, shareholders don't have to pay taxes on the sale of corporate assets during a liquidation. This occurs because the property never enters the possession of the shareholders. The IRS requires company executives to report the sale of the corporation's assets on the company's final tax return at the end of the year.
Liquidation in Bankruptcy
The court handles the liquidation of an S corporation's assets in Chapter 7 bankruptcy differently than if the business simply elected to close its doors voluntarily. The court appoints a trustee to oversee the sale of all the corporation's assets for the payment of its business debts and other outstanding financial obligations. Assets don't pass to shareholders as in other forms of liquidation, and the trustee has a legal obligation to distribute all proceeds in accordance with the security of the company's debts. For example, secured debts, including property loans, receive payments first. Unsecured debts, including credit cards, received distributions of cash last, if at all.