Liquidating corporation liabilities
Liquidating distributions are not governed by the normal S corporation distribution rules.
Instead, liquidation of an S corporation is governed by the same rules that apply to liquidation of a C corporation.
The shareholder’s basis is decreased (but not below zero) by the shareholder’s share of the S corporation’s items of loss and deduction, nondeductible expenses (except expenses that are not chargeable to the capital account), depletion deduction for oil and gas property, and distributions to the shareholder that are not made from accumulated earnings and profits.
Liquidation is a taxable event for both the shareholder and the corporation. Like the “Redemptions Not Equivalent to Dividends” test of I.
The shareholder will also have two tax consequences from the liquidation.
This means that the normal distribution rules of Section 1368 do not apply to liquidating distributions.
While there are differences, the S corporation basis system is similar to the rules that apply to partnerships.
The tax consequences of distributions by an S corporation to a shareholder depend on the shareholder’s basis in the S corporation stock.