Liquidating Dividend: Definition and Overview
A liquidating dividend (also called a liquidating distribution) is a payment a corporation makes to shareholders during a partial or full wind-down of the business. Unlike regular dividends paid from operating profits or retained earnings, a liquidating dividend is paid from the company’s capital base and represents a return of capital to owners.
How It Works
- A company may distribute liquidating dividends in one lump sum or in multiple installments as it disposes of assets and settles obligations.
- In the United States, corporations report liquidating distributions to shareholders on Form 1099‑DIV.
- Liquidating dividends are issued when the company is winding down operations or selling significant portions of the business; they are not funded by ongoing business earnings.
Tax Treatment (General)
- A liquidating dividend is generally treated as a return of capital. It typically is not taxed as ordinary income to the extent it does not exceed the shareholder’s cost basis in the stock.
- Receiving a liquidating distribution reduces the shareholder’s basis in the shares. Any distribution amount that exceeds the shareholder’s adjusted basis is usually treated as a capital gain.
- Tax rules and reporting can vary by jurisdiction; shareholders should consult a tax advisor for specifics.
How Liquidating Dividends Differ from Regular Dividends
- Source of funds: Regular dividends come from profits or retained earnings; liquidating dividends come from capital/cash from liquidation.
- Purpose: Regular dividends provide income from ongoing operations; liquidating dividends return invested capital when the business shuts down or is partially sold.
- Timing and entitlement: For regular dividends, entitlement is determined by record and ex‑dividend dates—owners of record on the applicable date receive the payout. Liquidating distributions follow the liquidation process and corporate decisions about asset sales and cash distributions.
Order of Claims in Liquidation
When a company liquidates, assets are distributed according to a priority of claims:
1. Secured creditors
2. Unsecured creditors (including bondholders, tax authorities, and owed wages)
3. Preferred shareholders
4. Common shareholders
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Shareholders receive liquidating dividends only after creditor claims and other higher-priority obligations have been satisfied.
What Investors Should Know
- Receiving a liquidating dividend often signals that the company’s operations have ceased or substantially changed and that the original investment may not be fully recovered.
- Distributions may be less than the initial investment if asset values or recoveries are limited after creditor payments.
- Keep records of distributions and basis adjustments for accurate tax reporting.
Key Takeaways
- A liquidating dividend is a return of capital made during partial or full liquidation of a company.
- It differs from regular dividends by source and purpose and is typically not taxed as ordinary income (subject to basis adjustments).
- Priority of claims determines whether and how much shareholders receive after creditors are paid.
- Consult a tax or financial advisor for guidance on reporting and implications for your investment.