Companies end their existence for a variety of reasons. In some cases, the company faces financial pressure from creditors that it can’t afford to pay. In other cases, the owners want to retire and close the business. Liquidation refers to the process of closing out the financial side of the business and distributing the assets.
In a complete liquidation, the company transfers 100 percent of its assets and liabilities to the shareholders. The company often hires an outside business to manage the liquidation process. The first step in the liquidation process involves identifying the company’s assets and liabilities. As long as sufficient assets exist to satisfy the creditor liabilities, the creditors are paid off. If there is not enough in assets to satisfy the creditor liabilities, each creditor receives a percentage of the debt. If additional assets exist after the creditors are satisfied, the remaining amount is distributed to the shareholders.
When a company redeems a portion of its outstanding stock, the proceeds to the shareholders are considered a partial liquidation distribution. Companies choose this option for several reasons. In some cases, a company ceases operations in one segment of the business due to vandalism or destruction of that facility. If the company distributes the insurance proceeds to the shareholders in exchange for their outstanding shares of stock, this represents a partial liquidation distribution.
Capital Gain or Loss
The shareholders who receive a partial or complete liquidation distribution need to determine if they experience a capital gain or capital loss as a result. The shareholder needs to know his basis in each share of stock. After looking at his records to determine what he paid for the stock, the shareholder compares this amount to the amount received in the liquidation distribution. If the liquidation distribution is greater than the shareholder’s basis in the stock, he experiences a capital gain. If the liquidation distribution is less than the shareholder’s basis in the stock, he experiences a capital loss. The shareholder will pay taxes on any capital gains.
A provisional liquidation provides protection for a company’s assets while the company is in the middle of liquidating. The court appoints an individual to serve as the provisional liquidator until the process of assessing the company’s assets and liabilities and distributing the assets is completed. A creditor, shareholder or director of the company may file for a provisional liquidation if they feel the assets are at risk.