When a company has more liabilities than assets, equity is negative and no liquidating distribution is made at all.
This is usually the case in bankruptcy liquidations.
Madison must recognize a $10,000 gain (all ordinary income).
The gain is passed through to the shareholder and has to be reported on his tax return.
If thedistribution exceeds the adjusted basis of the stock, the excess isordinarily taxed as capital gain, with an exception of minor importancefor distributions out of increase in the value of corporate propertyaccrued before March 1, 1913.
Instead of paying a dividend (in the case of a C corporation) or a distribution (for an S corporation) in cash, you may be tempted to distribute property (car, computer, etc.) out of the corporation. If an S corporation distributes appreciated property to its shareholders, the difference between the fair market value and the property's basis will result in a gain that will be passed through to the shareholders. (an S corporation) owns a truck that was purchased for $20,000.
A corporation may liquidate by (a) paying off creditors and distributing the remaining assets in kind to the shareholders or (b) selling assets, paying off creditors, and distributing the remaining cash to the shareholders.