When a corporation liquidates, what happens to the corporate debt? This is a common question many of our clients will ask a tax attorney or business attorney at The McGuire Law Firm. Our answer is usually, “it depends.” While this is a typical (and maybe expected) answer from an attorney, it is correct. The article below, drafted by one of our business and tax attorneys should help shed some light on the issue. As always, please contact our office with any questions regarding your business or tax issues.
The majority of states have state law that would require corporate creditors to be paid upon the liquidation of a corporation or cause third parties, such as the corporate shareholders to pay these corporate debts or assume the debts. If neither the corporation nor the shareholders were required to pay such debts, certain laws and other principles founded in equity will likely subject the shareholders to some form of transferee liability up to the value of the corporate assets received by the shareholders upon the corporate liquidation.
Often through a liquidation, the shareholders will receive corporate assets via liquidating distributions and assume these assets subject to the liabilities or assume corporate debt. If shareholders take property subject to debt or assume corporate liabilities, their gain must be reduced or their loss increased to the extent of the debt assumed.
For example, if through the corporate liquidation, John received a distribution of property with a fair market value of $100,000 and such property was subject to $50,000 of liability, and John had a basis in his corporate stock of $50,000, John would realize no gain on the liquidating distribution.
However, the above analysis could change if the shareholder is already liable for the debt they “assume.” This would occur if the shareholder made a personal guarantee on the debt or co-signed etc. Under such circumstances, the assumption of debt upon liquidation has been held to not reduce the amount realized. When the shareholder pays the debt of which they would have been personally liable, they may be able to deduct a loss given that the amount they realized was not reduced upon the liquidation. If the shareholder pays the assumed debt and that debt reduced the amount received through the corporate liquidation, they may not deduct the subsequent payments. This subsequent loss would likely be a capital loss due to the fact the shareholder would have recognized capital gain or capital loss upon the liquidation of the corporation. Such treatment would be in line with the Arrowsmith v. CIR case.
A Denver tax attorney at The McGuire Law Firm can assist clients regarding corporate liquidations, sales and purchases. All of these transactions have tax consequences and should be discussed with a tax attorney and/or a business attorney
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