What Happens to a Shareholder in a Dissolved Corporation?
The effect that corporate dissolution has on shareholders depends on the financial state of the corporation and on how the corporation dissolves. On the one hand, shareholders may see all or most of their original investment returned. On the other, shareholders may receive nothing or even be required to pay additional money if the corporation is insolvent or closes improperly.
Official dissolution is the first step in dissolving a corporation. Dissolution can occur voluntarily or involuntarily under a state mandate or court order. While shareholders have a voice in a voluntary dissolution, they don’t if the decision to dissolve is administrative or judicial in nature. The second step consists of winding up the business, notifying creditors and either paying or setting funds aside to pay debts when they become due. The final step is the liquidation phase. In this phase, the corporation distributes its remaining assets to shareholders if there’s anything left after the corporation pays its outstanding debts.
In a best case scenario, the corporation has leftover cash and other assets after paying its creditors and final taxes due. When this is the case, the leftover dollar amount is totaled and then divided between shareholders proportionate to the number of shares each shareholder owns. In exchange for returning part or all of a shareholder's investment, the shareholder returns their outstanding shares, and the deal is done.
The dissolution process is specific, and state laws expect corporations to complete each step in order. Because shareholders are part owners of the business, shareholders can face legal and financial consequences if a corporation doesn’t adhere to state requirements. For example, if a corporation returns any money to shareholders while it still has outstanding debt, the creditor can sue the corporation and the shareholder will most likely be required to return the distribution. If outstanding debt includes unpaid taxes, a shareholder may become personally liable for repayment.
Any shareholder receiving a distribution of $600 or more will also receive IRS Form 1099-DIV. The amount reported on the form represents how much of the shareholders’ investment the corporation is returning. The distribution isn’t taxable if the amount reported is less than or equals the original investment. If the distribution is less than the original investment, the shareholder can report a capital loss on annual income taxes. If the distribution exceeds the original investment, however, the excess is subject to short or long-term capital gains tax. Short-term capital gains tax applies if the investment was held for one year or less. Long-term capital gains apply if the investment was held for more than one year.