Liquidation is when a corporation's business is ceased and its assets are sold or distributed. Generally, liquidations are treated as exchanges under the tax code, with shareholder recipients recognizing gain to the extent that anything received exceeds their stock basis. As expected, there are a series of specific exceptions and adjustments that are each too specific to be mentioned. The general rule to remember, however, is that the liquidation of a corporation is treated exactly like an exchange of property.
For instance, suppose James owns 500 shares in TechnoCorp. at the time that this corporation is liquidated - shares for which he paid $5,000 a few years ago. James' basis in the shares is $5,000. If Kenny receives $10,000 worth of assets in the liquidation of TechnoCorp., his gain will be $5,000, not $10,000 - the total value received, minus the basis.
There is also a special rule under the tax code for a parent corporation liquidating a subsidiary. Generally, if a parent corporation owns more than 80% of a subsidiary, the liquidation of that subsidiary has no tax consequences. However, there are several special rules that govern this sort of a transaction under the tax code. Among other things, the parent corporation must succeed to the subsidiaries assets and liabilities.
For further reading on corporate liquidations, see:
Internal Revenue Code
§ 331 Gain or loss to shareholders in corporate liquidations § 332 Complete liquidations of subsidiaries § 334 Basis of property received in liquidations § 336 Gain or loss recognized on property distributed in complete liquidation § 337 Nonrecognition for property distributed to parent in complete liquidation of subsidiary § 338 Certain stock purchases treated as asset acquisitions § 346 Definition and special rule
|Distributions in liquidation of subsidiary corporation; general.|
|Requirements for nonrecognition of gain or loss.|
|Liquidations completed within one taxable year.|
|Liquidations covering more than one taxable year.|
|Distributions in liquidation as affecting minority interests.|
|Records to be kept and information to be filed with return.|
|Indebtedness of subsidiary to parent.|
|Basis of property received in liquidations.|
|Transitional loss limitation rule.|
|Old transitional rules imposing tax on property owned by a C corporation that becomes property of a RIC or REIT|
|New transitional rules imposing tax on property owned by a C corporation that becomes property of a RIC or REIT.|
|Tax on property owned by a C corporation that becomes property of a RIC or REIT.|
|General principles; status of old target and new target.|
|Nomenclature and definitions; mechanics of the section 338 election.|
|Qualification for the section 338 election.|
|Aggregate deemed sale price; various aspects of taxation of the deemed asset sale.|
|Adjusted grossed-up basis.|
|Allocation of ADSP and AGUB among target assets.|
|Allocation of redetermined ADSP and AGUB among target assets.|
|Asset and stock consistency.|
|International aspects of section 338.|
|Effect of section 338 election on insurance company targets.|
|Deemed asset sale and liquidation.|
|Collapsible corporations; in general.|
|Limitations on application of section.|
|Exceptions to application of section.|
|Certain sales of stock of consenting corporations.|
|Treatment of certain redemptions.|
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