If you own a small business and decide to close it instead of selling it, giving it to a family member or passing it to a successor, you’ll need a plan to deal with tax issues. For some businesses, winding up tax affairs can be a major component of shuttering business operations. It is important to take the time to be thorough in letting the IRS — as well as state and local tax authorities — know that your business is ending.
Your final state and federal income tax returns, on the whole, will look a lot like the income tax returns you have filed in the past. However, unless you are a sole proprietor, you will need to alert the IRS that this return is the last.
Partnerships and LLCs should check the “final return” box on Form 1065 and report distributed profits and losses on Schedule K-1. Corporations should check this box on Form 1120 and report shareholder allocations on Schedule K-1. For businesses operating in states that require them to collect sales tax, they should also mark their final state sales tax forms as “final” in the way the state in question requires.
If you have employees, your business will need to file its final quarterly or annual employment tax forms (Form 940 for annual returns or Form 941 for quarterly returns). Whichever form you file should also be marked “final.”
Your business will need to report withholding information from employees’ final W-2s and report information from any issued Form 1099s for independent contractors. Businesses that generate tips will also need to file final tip income and allocations. If you offered a Simplified Employee Pension (SEP) plan or a Savings Incentive Match Plan (SIMPLE), you will need to take the proper steps to shut down the plan in compliance with the law.
While selling your merchandise will have no extra tax consequences beyond those of any other sale, you will need to report the sale of any business asset. This is true even when your business is not closing, but it may not have come up earlier. For instance, if you run an ice cream shop, you regularly sell sundaes, but you may never have sold a soft-serve machine before. You will need to inform the IRS of the asset’s sale price, as well as its adjusted basis (what you paid for the asset less any depreciation). Use Form 4797 to report such sales, and note that they may sometimes trigger tax consequences.
In pass-through businesses such as partnerships, where owners have basis in the business as a whole, closing the business may also have direct tax consequences beyond asset sales. The level of your capital account after the business shutters represents a capital loss. In theory, this amount should be negligible if the business was in a position to distribute sufficient assets to offset partners’ capital accounts. It is even possible that, should the capital accounts end up negative because they were exceeded by distributions, the end of the business could represent a capital gain. Owners with basis in the company should consult a tax professional to make sure gains and losses are properly reported, as the rules around dissolutions are complex.
If your business has an Employer Identification Number, tell the IRS that it should close the account. And make sure your business has fulfilled any other particular state and local tax responsibilities. Obtain and keep a good-standing certificate from the relevant state tax authority.
Once your business has closed its doors, there are a few final steps you should take. Depending on your state’s laws, you may need to file an additional notice with the secretary of state confirming that all the business’ debts are paid and all its assets have been distributed.
Corporations, LLCs and partnerships also need to take steps to formally dissolve. The specific rules for each structure are governed by state law. In addition, corporations must file IRS Form 966 no later than two months and 15 days after the business closes.
It is wise to keep all records and documents connected to your business for seven years, in case you are audited or face other legal queries about your business’ operation or dissolution.
Properly winding up a business is arguably as complicated as starting one. However, with a comprehensive plan, good communication and a team of professionals to help, there is no reason the end of your business shouldn’t be as successful as its heyday.
Eric Meermann is vice president of Palisades Hudson Financial Group in Stamford. He holds the certified financial planner, certified valuation analyst and IRS enrolled agent designations. Palisades Hudson is a fee-only financial planning firm and investment manager with $1.4 billion under management. More information is online at palisadeshudson.com.