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How to Manage
the Tax and Legal
Issues of Closing
a Business
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 businesses’ 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 2 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.
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