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A fine line exists between definitions of a corporate liquidation and dissolution.But for tax purposes, the defining line can make a big difference.Balancing the tax advantages and disadvantages of dividends vs. Disclaimer Copyright © 2017, Endowment Development Services, Inc., 921 East 86th Street, Suite 100, Indianapolis, Indiana 46240. This service is designed to provide accurate and authoritative information in regard to the subject matter covered.It is provided with the understanding that neither the publisher nor any distributor is engaged in rendering legal, accounting, tax, investment, or other professional advice.Conversely, the stockholders record a loss (also, almost always a capital loss), if the net distribution is less than their adjusted basis in the stock surrendered in the transaction. Indeed, in that situation, the tax consequences spelled out in ( Section 331(a) and Section 336(a) will not be visited on the shareholders and the corporation, respectively.** Federal Law Governs The ruling concludes that the “core test of corporate existence,” for purposes of federal income taxation, is always, a matter of federal law.The transaction is treated somewhat differently if a shareholder owns more than one block of stock, and receives a series of distributions in complete liquidation. To be sure, since the state law in the IRS example brought about an automatic transfer (to its shareholders) of a dissolved corporation’s assets, it followed that the company’s dissolution did not give rise to a complete liquidation.
The tax treatment of the shareholders is governed by the tax code’s Section 331(a), which provides that amounts distributed in complete liquidation, “shall be treated as in full payment in exchange for the stock.” Generally, stockholders record a gain (usually capital in nature), if the net distributions of the surrendered stock is greater than the shareholder’s adjusted basis in the stock. If state law allows a dissolved company to own assets, the dissolution, unless accompanied by an actual conveyance of the entity’s assets to its shareholders, will not give rise to a liquidation.
Mutual fund dividends will be eligible only to the extent they represent dividends the mutual fund earned on stock, and not on other types of fund earnings such as interest.
Mutual funds will report to individual investors the portion of their dividends eligible for the reduced rates.
Ineligible Dividends The special tax rates do NOT apply to dividends paid by, among other things: Mutual insurance companies Credit unions, mutual savings banks, savings and loans, and certain other types of financial institutions Nonprofit voluntary employee beneficiary associations (VEBAs) Employer securities owned by an employee stock ownership plan ( ESOP) to the extent the dividends are deductible under IRC Sec.
404(k) Stock purchased with borrowed funds when the dividend was included in investment income for purposes of claiming an investment interest deduction Tax-exempt corporations under IRC Sections 501 or 521 Farmers’ cooperatives Foreign personal holding companies Foreign investment companies Passive foreign investment companies Stock owned for 60 days or less in the 120-day period beginning 60 days before the ex-dividend date (when the corporation makes final the shareholders who will receive the dividend).Moreover, dividends are not subject to payroll taxes, unlike compensation.