Distributions, Redemptions & Liquidations

Distributions

• Order: current earnings and profits (E&P) → accumulated E&P → return of capital → capital gain.
• Appreciated property: corporation recognizes gain (no loss); shareholder basis = fair market value (FMV).
• Stock dividends: generally tax-free.

Redemptions — exchange if

• Substantially disproportionate: after < 50% and < 80% of before.
• Complete termination (family attribution waivable for 10 years).
• Not essentially equivalent to a dividend; partial liquidation; Section 303 (estate > 35%).
• Attribution (Section 318): spouse, children, grandchildren, parents — not siblings.

Liquidations

• Complete: corporation taxed on gains (loss limits for related parties); shareholders capital gain or loss; basis = FMV.
• Parent owns ≥ 80%: tax-free; carryover basis and attributes.

Pass-throughs

S corporations and partnerships: generally tax-free to basis; one level of tax.

Exam traps

• A stock dividend that shareholders could have taken in cash instead is taxable.
• The family attribution waiver fails if the shareholder keeps any interest — including as an officer, director or employee.
• In a liquidation of an 80%-owned subsidiary the parent recognizes no gain, but minority shareholders are taxed.
• Distributions can't make accumulated E&P negative — only operating losses can.