What Is a Cash Liquidation Distribution?
A cash liquidation distribution, also known as a liquidating dividend, is the amount of capital returned to the investor or business owner when a corporation is partially or fully liquidated. When a company goes out of business and its assets are liquidated, the firm either issues non-cash liquidating distributions, cash liquidating distributions, or both.
The distributions are returned to investors per the capital structure of the business. If money is left after paying bondholders, stockholders are paid a portion of the money. Distributions to investors up to their cost basis—the amount invested, including commissions and fees—in the stock is considered a non-taxable return of principal.
Amounts above investors' cost basis are reported as capital gains, a taxable distribution. Amounts below investors' cost basis are reported as capital losses. Credit unions send this sort of distribution to their depositors when they are liquidated, as well.
Understanding Cash Liquidation Distribution
Proceeds from a cash liquidation distribution can be either a non-taxable return of principal or a taxable distribution, depending upon whether or not the amount is more than the investors' cost basis in the stock. The proceeds can be paid in a lump sum or through a series of installments.
Often, proceeds from cash liquidation distributions are reported on Form 1099-DIV. The IRS mandates in section 331(a) of the IRS Tax code that distributions of $600 or more must be reported on Form 1099-DIV. Any taxable amount the investor receives is reported on Schedule D, the capital gains and losses statement that is filed with the IRS form 1040 during yearly tax filings.
Payments in excess of the total investment are capital gains, subject to capital gains tax. If the amount the investor receives is less than their original cost basis invested in the stock, the investor may report a capital loss which reduces their tax bill. This loss can only be reported once the firm issues a final cash liquidation distribution.
The duration of the holding period determines whether the capital gains are classified as short-term or long-term gains.
Example of a Cash Liquidation Distribution
XYZ Corporation is going through liquidation. Bob and Bette are shareholders. Bob' s cost basis of his shares in XYZ Corp. is $50. When he receives a cash liquidation payment of $75, $50 of that is a return of capital and is not taxable, while $25 is the gain and is taxable. Bette has an original cost basis of $100. When she receives her payment of $75, it does not cover his original cost basis in the stock. So Bette has a loss of $25.