Liquidating dividends and tax treatment

While seller warranties may assuage a buyer’s reluctance, they are only as comforting as the seller’s ability to make good on them.There are cases, however, where the buyer may have no choice but to buy shares rather than the underlying assets.This difference is even greater when taking into account state taxation.A usual approach to managing the inefficient taxation of C corporation operating income has been to pay as much of the income as possible to shareholder-employees in the form of compensation, which, unlike dividends, is deductible. 162 allows a deduction for compensation that is (among other things) “reasonable.” Where a large percentage of corporate earnings is paid as compensation, particularly where the compensation is proportionate to shareholdings, the reasonableness of it may be difficult to defend.This can occur, for example, where the corporation holds a valuable asset such as a lease that is not transferrable, or where the corporate charter itself has value, as in the case of a bank or insurance company.

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Tax advisers should be talking to their C corporation clients about the opportunities that now exist to avoid substantial future taxes.

Thus, the total federal tax rate on distributed earnings from a C corporation is 44.75% [(1 × 0.35) (.15 × (1 – 0.35)].

If a corporation has elected to be an S corporation or a business is not operated in corporate form (e.g., partnership, limited partnership, or limited liability company (LLC)), there is only one level of taxation at the owner level, and a savings of 9.75% of taxable income, assuming the owners are individuals taxed at the highest individual rate.

The shareholders would pay tax on gain equal to the difference between the sales price and their basis in their shares.

Assuming that the shares are long-term capital gain property, the shareholders would face only a 15% federal tax.

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