When you decide to close your business, whether the decision is based on plans for retirement or economic factors, taking a deliberate, methodical approach to dissolve a business is very important. This deliberate approach includes planning ahead (whenever possible) to meet tax filing requirements and other small business tax requirements associated with dissolving a business (dissolution). When dissolving a business, the dissolution process is executed through the Secretary of State’s office. Therefore, if you know that you are going to be closing your business, it is wise to do your due diligence well ahead of time, not waiting until you are in the process of closing the business.
Closing your business: What sellers need to know regarding tax matters
Follow these steps when you decide to close your business:
- File dissolution documents if the business structure is other than a sole proprietorship
- Cancel registrations, permits, business licenses, and business name(s) – DBA’s
- Comply with employment and labor laws requirements
- Resolve financial obligations, pay off all remaining debts or cancel accounts
- Maintain your business records for up to seven years, as recommended by the IRS
We know that closing your business can be pretty stressful. Following is more detail for the steps to take, from a tax standpoint:
- File the final tax return and related forms for both state and Federal
Federal:
You must file a tax return and all related forms for the year that you close your business. The type of tax return to be filed depends on your business structure.
- Sole Proprietorship: Schedule C (Profit or Loss from Business)/along with the Form 1040
- Single Member LLC: Schedule C (Profit or Loss from Business)/along with the Form 1040. Be sure to check the box that the business is an LLC
- Multi-Member LLC that has not elected to be taxed as a corporation: Form 1065 (U.S. Return of Partnership Income). A multi-member LLC that has not elected to be taxed as a corporation automatically defaults to partnership status.
- S Corporation: Form 1120S (U.S. Tax Return for an S Corporation)
- C Corporation: Form 1120 (U.S. Corporation Income Tax Return)
State:
If you have a business registered with your state, you will need to formally dissolve the business through the state’s process. You’ll need to have a resolution of dissolution (an official vote, even if only one person is voting), then you’ll need to file a notice of dissolution with your state.
Some states impose an annual franchise fee for businesses. Formally dissolving your business on the state level, you will no longer have to pay this fee. If you do not formally dissolve the business on the state level and the state imposes an annual franchise fee, you will still be responsible for paying that annual fee, plus penalties and interest if you’re late, until you formally dissolve the business. Dissolving the business is usually done through the Secretary of State’s office and you should be able to find the process on your Secretary of State’s website.
Regarding the Resolution of Dissolution: To dissolve the business, your business must have a formal agreement by the owners to do so. Even if you have a single-member LLC, it is recommended to have this document. This document does not need to be filed with the state. However, there must be evidence that the shareholders, partners, or members have formally approved the dissolution.
The Dissolution document that you file may vary from state. The dissolution notice must be filed with the state’s business or corporate division, which is part of the Secretary of State’s office.
2. Take care of your employees
Employment Taxes
If you have one or more employees, you must pay them any final wages and other compensation owed. You must also make final federal tax deposits and report employment taxes. If you don’t withhold or deposit employee income, Social Security, and Medicare taxes, you may get hit with the Trust Fund Recovery Penalty.
To report employment taxes, you may need to file the following forms:
- Form 941, Employer’s Quarterly Federal Tax Return, or Form 944, Employer’s Annual Federal Tax Return, for the quarter in which you make the final wage payments. Be sure to check the box to let the IRS know that your business has closed and entered the date the final wages were paid in the applicable area on the form (line 17 on Form 941 or line 14 of Form 944). You’ll also need to attach a statement to the return showing the name of the person keeping the payroll records and the address where the records will be kept.
- Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, for the calendar year in which you paid the final wages. Check box “d” in the Type of Return section to show that the form is final.
You must also issue a Form W2 (Wage and Tax Statement) to each of the employees for the calendar year in which you paid the final wages. If your employees receive tips, you must file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips, to report final tip income and allocated tips. You’ll also need to make payments to independent contractors that were paid $600 or more during the calendar year. Refer to Paragraph number 4 (below) for more details.
For single owners and operators who are sole proprietors with no employees, do the following:
- Cancel registrations, permits, licenses, and business names
- Resolve financial obligations
- Maintain records for up to seven years
- No longer file the Schedule C for future years
Step 5 will also apply to a sole proprietor if he or she has been using an EIN.
Pension or Benefit plans
If you provide a pension or benefit plan for your employees (a 401k or ROTH plan for example), you must terminate that plan. The same thing goes for a Health Savings Account or similar program for your employees, you must terminate the plan or program. You will do this by contacting the Plan Administrator. It is required that employees receive notification of plan termination at least 60 days prior to the plan termination date. Refer to IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health plans.
3. Pay all your tax liabilities
4. Report payments to contract workers
If you paid any contractors workers $600 or more (including parts and material) during the calendar year in which you close a business, you must report those amounts to the contractor and the IRS on Form 1099-NEC, Non-Employee Compensation.
Use the Form 1096, Annual Summary and Transmittal of U.S. Information Returns to send copies of the 1099s to the IRS. Some filers are required to file 1099 forms electronically.
5. Cancel your EIN and Close Your IRS Business Account
To cancel your EIN and close your IRS business account, you will need to send a letter to the IRS that includes the following information.
- The complete legal name of the business
- The business EIN
- The business address
- The reason you wish to close the account
If you still have the notice that the IRS sent to you when the EIN was assigned, you should enclose a copy of it with your EIN cancellation letter. Send both documents to the IRS at:
Internal Revenue Service
Cincinnati, OH 45999
Note that the IRS cannot close your business account until you have filed all necessary returns and paid all taxes owed. Remember to keep a copy of everything that you send to the IRS.
6. Keep Your Records
What’s recorded in each document determines how long you need to keep business records.
Property records. Keep records relating to property until the period of limitations expires for the year in which you dispose of the property. The period of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax.
Employment tax records. Keep these records for at least four years.
Final Thoughts
As you now know, closing your business is a lot more involved than just locking the doors and calling it quits. To properly close the business and to make sure that nothing unexpected creeps up years later like a huge tax bill, following the steps and suggestions mentioned in this document you should be good to go. ExitGuide wants you to be in the know. After all, knowing… is half the battle.