What Happens to Retained Earnings in a Corporate Liquidation?

by Rod Howell; Updated September 26, 2017

Retained earnings are corporate profits not distributed to shareholders. Corporations use retained earnings to fund projects and to support the growth of their business operations. If corporations file for bankruptcy, they use retained earnings to pay off their debts as part of the liquidation process. However, not all corporations are able to retain earnings.

Retained Earnings Basics

Retained earnings are important to the growth of corporations, which use these profits to fund projects to expand corporate operations such as building renovations and land acquisitions. According to Nolo, the IRS limits how much profits corporations can retain. Most corporations can retain up to $250,000. Corporations that professionals such as lawyers, doctors and real estate agents own have a limit of $150,000 in retained earnings.

Liquidation Process

When corporations file for bankruptcy, they have to liquidate all of their assets to pay back creditors, including retained earnings. Creditors are first in line to receive assets from the liquidation process, according to the U.S. Securities and Exchange Commission. If a corporation has any assets left after it has paid creditors, investors who own company stock receive the remaining amount.

S Corporation Exceptions

However, not all corporations can retain earnings. S corporations, which are a subchapter of the regular or C corporation, cannot withhold profits from distribution to its shareholders. This is because all profits and losses pass through to corporate shareholders and the IRS taxes this as personal income. This is different from regular corporations, where the IRS taxes company profits, including profits retained before distributing to shareholders, at the company level.

Limited Liability Protection

In corporate bankruptcy, creditors can only come after the retained earnings and other business assets of corporations to satisfy debts. However, they cannot come after the business owners' personal assets, including their homes, cars and other possessions. This is due to the limited liability protection afforded to business owners by the corporation business structure.