What are the tax consequences of dissolving a business?
The tax effects of dissolving a business depend largely on the type of organization you are closing. The following summarizes, by business type, the tax implications of closing a business and will give you a general sense of your obligations. If final taxes are owed, there are several ways to make those payments.
Liquidating distributions to corporate shareholders from dissolving the business are taxed under IRC Section 331. C-Corporations are subject to "double taxation," meaning that the corporation itself is obligated to pay taxes on assets distributed to shareholders and the shareholders are taxed on resulting gains or losses on their individual income tax returns.
S-Corporations are normally "pass-through" entities for tax purposes, meaning that the company's profits and losses are reported on individual shareholders' tax returns. However, these distribution rules do not apply to liquidating distributions. An S-Corp is subject to the same tax rules that apply to the distribution of C-Corp assets when it closes. In other words, both the corporate entity and its shareholders must recognize gains or losses from dissolution.
LLC income is "pass-through" income to its shareholders, either as sole proprietorship income (the default when the LLC has just one member) or as partnership income. This tax treatment will continue during the process of closing up the business, meaning that each individual LLC member is responsible for reporting their share of distributed company assets and their share of the company's gains or losses in its final tax period.
Federal law requires nonprofits that are dissolving to distribute any remaining assets only to another tax-exempt organization. There will generally be no income tax payments owed to the federal government upon dissolution if the nonprofit meets these requirements and continues to operate under IRS rules governing charitable organizations during its final tax period.
Do I need to file any forms to dissolve my business?
Operating a small business involves meeting various recordkeeping requirements, regardless of the industry or the company's products or services. The same is true of dissolving a business.
C-Corp and S-Corp forms
If you are closing a C-Corp, you will need to file Form 1120 (U.S. Corporate Income Tax Return) with the IRS and report gains and losses on Schedule D. Similarly, closing an S-Corp requires the filing of Form 1120-S (U.S. Income Tax Return for an S Corporation), using its Schedule D to report gains and losses. On both of these forms, there is a "final return" box that must be checked. If the closing occurs pursuant to a board resolution or other plan to close the company or liquidate its stock, Form 966 (Corporate Dissolution or Liquidation) must also be filed.
Sole-member LLCs are considered sole proprietorships by default for tax purposes. You can document that you closed the business during the tax year on Schedule C of your tax return when filing your individual income tax return for the final year the company was in business. LLCs taxed as partnerships will check the box documenting that the business closed on Form 1065 (U.S. Return of Partnership Income) and report gains and losses on Schedule D and on Schedule K1 (Partner's Share of Income, Deductions, Credits, etc.).
Nonprofits must notify the IRS that the business has terminated and file Schedule N of Form 990 with the IRS to document remaining corporate assets and how they were distributed.
Some businesses will also need to file additional documents, such as forms documenting the sale or exchange of business property or an asset acquisition statement if the company is sold.
Close your IRS account
Businesses of any type should send the IRS a letter documenting the name of the business, its EIN, and its address in order to close the company's IRS account and cancel the EIN.
Are there any tax considerations when closing a small business with employees?
Business owners dissolving companies with employees must also make final payroll tax deposits and report employment taxes using the applicable quarterly or annual payroll tax return forms and Form 940 (Employer's Annual Federal Unemployment (FUTA) Tax Return).
Employers are also required to provide employees and the IRS with their final wage reports using Form W2 (Wage and Tax Statement) by the due date of the final quarterly payroll or annual payroll tax deposit. Similarly, if your business paid more than $600 in its final tax period to a contract worker for services, you must provide the contractor with Form 1099-NEC (Nonemployee Compensation).
How long should I keep business tax records after closing a small business?
Records related to employment taxes should be maintained for at least four years after closing your business. Other business tax records must be kept until the applicable period of limitations—the time during which you could amend your tax return to claim a refund or credit, or during which the IRS could assess additional taxes—has expired. IRS tax record retention time periods range from three years to indefinitely, depending on the circumstances.
Seek assistance when needed to ensure you comply with tax requirements
Please note that the tax consequences and requirements outlined above address only federal tax obligations. Your business may have additional requirements and different timelines for state and local tax authorities. Failing to file the appropriate forms or manage your business's tax obligations can result in fines and penalties, not to mention the headaches associated with resolving tax problems. If you have tax questions or need assistance, talk to a tax professional or a Rocket Lawyer On Call® tax attorney.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.