Tax Consequences When Liquidating U.S. Corporations with Foreign Shareholders
If you are considering liquidating a U.S. Corporation, there’s a complex web of potential tax and regulatory issues you should be aware of, especially if the liquidation involves a foreign company or a foreign shareholder
The tax treatment of the liquidation depends on several factors such as if the shareholder is an individual or another corporation, the ownership percentage, and whether the U.S. corporation holds significant Real Estate assets such that qualifies as a “United States Real Property Holding Corporation.”
Qualification for Tax-Free Treatment
The first order of business: Determine whether the liquidation qualifies for nonrecognition treatment under IRC Section 332, or results in taxable exchange treatment under Section 331.
Each of these statutory provisions involve different withholding and reporting requirements.
Section 332 Non-Taxable Liquidations
In a purely domestic context, under Section 332 a corporate parent company owning 80% or more of the stock of a U.S. subsidiary is entitled to non-recognition (tax-free) treatment in connection with the liquidation of such qualifying subsidiary. (Individual non-U.S. shareholders, see the section on individuals below). Where Section 332 applies the parent company is not required to recognize capital gains or losses or dividend income upon the liquidation of its subsidiary. In addition, under Section 337, the liquidating subsidiary generally recognizes no gain or loss on the distribution of property to its shareholders in complete liquidation. However, in a case where the parent company is a foreign corporation, except in three situations, Section 367(e)(2) and the related regulations require that the U.S. liquidating company recognize gain and loss on the distribution of its assets in complete liquidation.
Briefly stated, the three exceptions to the requirement that the liquidating subsidiary recognize gain or loss on the liquidating distribution are:
- The foreign parent must use the distributed property in a U.S. trade or business for a 10-year period beginning immediately after the liquidation. However, gain must be recognized with respect to any intangible property distributed by the liquidating subsidiary even if such property is used in a U.S. trade or business for the above mentioned 10-year period. Among other things, intangible property includes patents, know-how, copyrights, trademarks, franchises, licenses and customer lists.
- The U.S. liquidating corporation must comply with specific reporting and procedural requirements.
- The foreign parent must comply with certain disclosure requirements.
Impact of the Recent Tax Reform (OBBBA) on Liquidations of a US Company Owned by a Foreign Parent Company
The OBBBA ensures that the liquidating U.S. subsidiary will not be inadvertently treated as a controlled foreign corporation (CFC) due to the “downward attribution” of stock from a foreign shareholder. This avoids the many ancillary complications associated with the liquidation of a CFC and thus simplifies the process of liquidation.
Other Considerations
Compliance When a U.S. Corporation has Foreign Shareholders
When a foreign shareholder holds more than 25% of the shares of a U.S. Corporation, the U.S. entity is subject to additional reporting requirements. Specifically, it must file form 5472 to disclose certain transactions between the U.S. corporation and the foreign shareholder. Failure to comply with this filing obligation can result in substantial penalties.
There may also be compliance filings, such as Form 1120-F or IRS Form 926.
Filing a Formal Liquidation Plan
To qualify for Section 332 tax-free treatment, you must complete a formal liquidation plan, and file an IRS Form 966 with a certified copy of your plan.
Timeline
To qualify for tax free treatment, you have two timeline options in terms of timeline:
- One-year option: Complete liquidation within the same tax year as your formal liquidation plan, or;
- Three-year option: Complete within three years from the close of the tax year of the first distribution
Sell U.S. Corporate Assets Rather Than Distributing Them To Yourself
If you’re a non-U.S. individual, either a resident or non-resident alien, consider selling assets at the corporate level first. Notwithstanding that tax may be imposed at the corporate and shareholder levels, in some cases this may be a better option than distributing highly appreciated assets directly to the shareholder for the following reasons:
This approach gives you more control over when and how you recognize income.
You can also create separate entities to hold certain types of assets.
These moves may also help you sidestep some restrictions on taking assets out of the U.S. under Section 367(e)(2).
Section 331 Taxable Liquidations
U.S. Tax Treatment of Foreign Shareholder(s)
A complete liquidation of a corporation which does not qualify for special treatment under Section 332 (as explained above) is treated under IRC Section 331. Under Section 331, distributions of money and property to the shareholders of the liquidating company are treated as amounts received “in full payment in exchange for the stock.” Therefore, from the perspective of the shareholder(s), these transactions are generally treated as sales or exchanges of their stock in the liquidating corporation resulting in the recognition of capital gain or loss. This contrasts with the receipt by a shareholder of a non-liquidating distribution which generally results in the recognition of higher-taxed dividend income. This difference in treatment is especially significant for a foreign shareholder of a U.S. company. This is because the receipt of a dividend from a U.S. company by a foreign shareholder is generally subject to U.S. withholding tax of 30% unless the foreign shareholder qualifies for a reduced withholding rate under a tax treaty. On the other hand, a capital gain realized by a foreign shareholder derived from the sale of the stock of a U.S. company is not subject to U.S. tax or U.S. withholding tax unless the capital gain is “effectively connected” with a U.S. trade or business. This is generally not the case unless the liquidated U.S. company is a U.S. real property holding company by virtue of its present or past ownership of substantial U.S. real estate assets.
Tax Treatment of Liquidating Corporation
Under Section 336, the liquidating corporation must recognize gain or loss on the distribution of property in complete liquidation as if such property were sold to the shareholders at fair market value. Special rules apply to the distribution of property subject to a liability or where a shareholder assumes a liability of the liquidating corporation. Finally, various rules limit the recognition of taxable loss in particular situations.
Conclusion
With so many OBBBA decisions coming into effect at the beginning of 2026, timing your transaction is critical:
If you liquidate your U.S. company before December 31, 2025, you’ll operate under the current rules—which in certain limited circumstances may have an adverse tax effect on foreign investors since the 2017 tax reform. In such a case, it may be preferable to wait until 2026 as you might benefit from more lenient CFC rules that make it easier to qualify for tax-free liquidation treatment under Section 332.
On the other hand, you’ll also face new compliance requirements and reporting obligations.
