A liquidating dividend occurs

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If the corporation distributes its assets for later sale by the shareholders, the assets generally “come out” of the corporation with a basis equal to FMV (and with the related recognition of gain or loss under Sec.331 for the difference between the FMV and the shareholder’s basis in the stock).In this case, the contributed capital account is debited on the date of declaration.Many states have laws that restrict liquidating dividends in order to protect creditors.In other words, this is a return on the investors’ investment in the company.

To understand how a liquidating dividend works, you have to understand how a regular dividend works.

The shareholder does not recognize and report additional income as it collects the receivable because the shareholder has already included this amount in its gain or loss computation when it received the liquidating distribution. The full amount (100%) of all distributions made after basis has been recovered are recognized as gain.

But if the amount of the receivable that the shareholder ultimately collects differs from the amount that the corporation distributed, the shareholder recognizes gain or loss for the differences in the amounts reported and collected. Observation: The current reduction of the maximum tax rate on capital gains and on qualifying dividends to 15% through 2012 somewhat mitigates the traditional preference for a sale or exchange transaction (e.g., a Sec. However, under current law, distributions made after 2012 will be taxed at higher capital gain and dividend rates.

Definition: A liquidating cash dividend is a distribution to that returns some of the original investment to the owners.

In other words, a liquidating cash distribution gives some of the investors’ investment back to them.

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