A stock liquidation occurs when stock shares are converted into cash. In most instances, stock liquidation occurs when shareholders sell their shares on the open market for ready cash. Other examples are when one company acquires another and sells off its shares and when a company ceases operations. Each of these transactions has specific rules that allow the sellers to comply with federal securities trading and tax laws.
The most frequent method of stock liquidation takes place when an individual or group of investors sells shares of stock in a portfolio. These investors order their sales through stockbrokers, who must follow regulations set by the U.S. Securities and Exchange Commission. If the sale price is higher than the purchase price, the investor makes a profit. If the sale price is lower than the purchase price, the result is a capital loss. The Internal Revenue Service enforces specific rates and rules on capital gains and losses.
When one company acquires a subsidiary firm, the parent company may liquidate its shares in the subsidiary in stages, rather than selling them all off at once. The acquiring company could also convert shares of the subsidiary into its own shares on a fractional basis and liquidate the remaining fraction of the subsidiary stocks. These are known as "partial liquidations." IRS rules state that the distribution of proceeds from a partial liquidation must be part of a plan made within the current tax year that is approved or enacted within the following taxable year.
Closing the Doors
The worst outcome for a stock liquidation occurs when the company goes out of business. The stock liquidation terminates the shareholder's interest in the company in exchange for the cash proceeds from the stock sale. Federal trading regulations state that companies must evaluate the profit or loss on the distribution of the proceeds from a complete liquidation as if the stock were sold at its fair market value.
If the proceeds from a stock liquidation result in a profit for the investor, the profit is subject to the capital gains tax rate. The capital gains rate is typically lower than the earned income tax rate. If the investor took a loss on the sale, up to $3,000 of that loss can be claimed on that year's income taxes. Any losses over $3,000 can be carried forward to income tax returns in future years.
- Digital Vision./Photodisc/Getty Images