The debts still exist in theory, at least until the statute of limitations has expired, but there is no debtor to pay them, so they must be written off in practice.
Assets are distributed based on the priority of various parties’ claims, with a trustee appointed by the Department of Justice overseeing the process.
Imagine this scenario: XYZ Company (Company) has been a long time customer of ABC Bank (Bank).
The Company has an asset-based loan with the Bank and its borrowings are subject to a typical borrowing base formula.
This is because the liquidation transaction will generate a substantial capital loss that offsets a portion (and sometimes all) of the capital gain recognized on the sale of S corporation assets.
Note that liquidating in the next tax year can be a disaster: the capital loss is recognized in the year of the liquidation, but cannot be carried backward, and, if large, the carry-forward capital loss may not be used easily,especially by a taxpayer who is older, is retiring as a result of the transaction, and may not have many other business/ investment assets with a lot of built-in LTCG.
If that does not cover the debt, they will recoup the balance from the company’s remaining liquid assets, if any. These include bondholders, the government (if it is owed taxes) and employees (if they are owed unpaid wages or other obligations).
Finally, shareholders receive any remaining assets, in the unlikely event that there are any.
This is not the same as its debts being discharged, as happens when an individual files for Chapter 7.
Assume the S corporation agrees to sell its assets to a buyer.
As discussed in a prior post, the buyer and all S corporation shareholders can elect to treat the transaction as an asset sale even if the form is a stock sale.
In such cases, investors in preferred stock have priority over holders of common stock.
Liquidation can also refer to the process of selling off inventory, usually at steep discounts.
The company’s operations are brought to an end, and its assets are divvied up among creditors and shareholders, according to the priority of their claims. Not all bankruptcies involve liquidation; Chapter 11, for example, involves rehabilitating the bankrupt entity and restructuring its debts.