Considering alternatives to liquidation: in many situations, there are alternatives to liquidation that will better meet the objectives of the corporation's shareholders.

• Author: Ellentuck, Albert B.

Shareholders might want to liquidate a corporation for several reasons including, among others, a division among the shareholders of the corporate assets, sale of the business operated within the corporation, a desire to operate the business as a sole proprietorship or partnership, avoidance of double tax on corporate earnings, and avoidance of personal holding company (PHC) status. In some cases, a plan of action other than liquidation might better meet these objectives.

Determining Available Alternatives

All alternatives should be considered before deciding to liquidate. One option is a sale by the shareholder of the corporate stock to the corporation in a redemption transaction (assuming the shareholder is not the sole owner) or to another shareholder, rather than a sale by the corporation of its assets. A variation of this option is sale of the stock to an employee stock ownership plan (ESOP). Another option is a reorganization of the corporation.

Alternatives for Avoiding Double Taxation

As an alternative to liquidating a C corporation, certain entities might be able to elect S corporation status or structure a tax-free divisive D reorganization.

Electing S Corporation Status

Entities that can qualify as an S corporation can consider electing S status since, as passthrough entities, they generally would not be subject to entity-level taxes. However, to prevent the use of an S election as a method of avoiding corporate-level taxes on a liquidation, Sec. 1374 imposes a tax at the corporate level on the built-in gain of a C corporation that elects S corporation status. An S corporation that was formerly a C corporation will be subject to tax on gains from the disposition during a limited period of time (the recognition period) of appreciated assets on hand on the date the S election is effective (see Sec. 1374(a)).

Therefore, this planning opportunity is only beneficial when there are no plans to liquidate the S corporation during the recognition period after electing S status.

S corporations are subject to numerous qualification requirements and restrictions that may preclude the C corporation from qualifying as an S corporation and retaining the S status.

Reorganizing the Corporation

A corporate reorganization should be considered when the proposed liquidation is not due to a failed business but rather to disharmony among shareholders.

A divisive D reorganization results in the separation of a single corporation into two or more...