Whether due to retirement, a shift in focus, or other reasons, closing a business is a significant decision. The process requires careful planning to ensure all loose ends are properly closed. This guide outlines the essential steps for business owners to take, particularly when managing assets, tax accounts, and state filings.
Step 1: Address Business Assets
The first step in closing a business is to address your business assets. Start by inventorying all assets owned by the business, including equipment, furniture, inventory, intellectual property, and financial accounts. From this list, you will determine how to handle each asset.
Assets such as equipment, inventory, and any other physical assets may be sold or otherwise liquidated. You can then use the proceeds to pay off outstanding debts or distribute the proceeds to stakeholders of the business. If assets are transferred to a successor or another business entity, document the transaction (book value, fair market value, transferee, etc.) for tax purposes.
Don’t forget about receivables! If your business has any AR, you need to make sure to collect as much of it as possible for earned revenue. Communicate with your customers/clients to ensure timely payments, and to make sure all obligations are satisfied between the business and customers/clients.
You might have payables, too. It’s crucial to settle any financial obligations before closing the business. Notify creditors of your intent to close the business and pay off any loan balances. Maintain records of all debt payments so that you have proof of settled accounts. This protects remaining assets from false claims and protects your financial reputation as a business owner.
Step 2: Close Tax Accounts
Closing your business also involves properly closing out your tax responsibilities. You’ll need to notify all relevant agencies and close all associated tax accounts.
Notify the IRS by filing your final tax return, clearly indicating that it is the last return for the business by checking the appropriate box (usually on the first page of the return). For corporations, you’ll also need to report IRS Form 966 to report the corporate dissolution.
Settle all outstanding tax obligations, including sales tax, payroll tax, and income tax. If you’re obligated to make estimated tax payments throughout the year, make sure these are up to date as well.
Once all tax obligations are resolved, notify the IRS that your EIN is no longer in use. You can do this by sending a letter to the IRS describing the reason you are deactivating your EIN (business closure), and identifying your EIN, legal name and address, and a copy of your EIN assignment letter if you have it. Full details are on the IRS website, linked here.
You will also need to close your state and local tax accounts as well. These typically include sales tax and payroll, if nothing else. This includes canceling sales tax permits and closing unemployment insurance accounts. You may need to contact your taxing agencies specifically for those instructions, as they vary from jurisdiction to jurisdiction. File any final returns and remit any remaining penalties to avoid penalties.
Step 3: For S-Corporation Owners Distributing Assets
For owners of S-Corporations, distributing assets as part of the business closure (Step 1) has specific tax implications. Any distribution of business assets to yourself, as the business owner, is treated as a taxable event on your personal return. Here are some key points to keep in mind and specific items to document to make your next tax return preparation after closing the business go as smoothly as possible:
When assets are distributed to the business owner, the transaction is treated as a sale for tax purposes, and the fair market value (FMV) of the distributed asset is considered taxable income even if no cash is exchanged.
If the FMV of the distributed asset exceeds the adjusted basis (book value), the difference results in a taxable gain. The gain may be treated as capital gain or ordinary income, depending on the type of asset and how long it was held by the business.
If the FMV of the distributed asset is less than the adjusted basis (book value), the S-Corp may recognize a loss, which could offset other income on the business’ final tax return.
Shareholders will report their share of the distribution on their personal tax returns, as reflected on the final Schedule K-1.
You’ll need to keep careful documentation of how the assets are distributed if they are distributed to the liquidated business owners to help avoid unexpected liabilities. We also recommend working with a tax advisor to determine the most beneficial way to structure the asset distributions. To minimize complications, you may prefer to liquidate (sell) the assets as much as possible before dissolving the business, instead of distributing the actual assets to the business owners.
Step 4: File Final Documents with the Secretary of State
Finally, file dissolution paperwork with your state’s Secretary of State to formally close your business. This officially terminations the legal existence of your business.
Additionally, close or cancel all business licenses and permits with state and local authorities to prevent unnecessary renewal fees or penalties. This is a good time to double-check that all state and local tax accounts have also been closed and do not have any balances.
Provide final notice to your vendors, customers, and partners about your business closure. Verify that any outstanding contracts and agreements have been settled and retain copies of all relevant closure documents.
Step 5: Keep Copies
Maintain copies of all dissolution documents, tax returns, and financial statements for at least seven years. This will help you resolve any post-closure issues or audits, should they arise. After seven years, the statute of limitations has passed, and you can discard documentation.
Bonus Tips for a Smooth Transition
Closing your business is a complex process, but with careful planning and attention to detail, you can complete the process efficiently and move forward confidently. In addition to the official filings discussed above, manage your relationships carefully to ensure there are no surprises.
If you have employees, provide them with plenty of advance notice of the business closure, and clear guidance regarding final paychecks, benefits, and unemployment claims and processes.
Communicate openly with your customers, letting them know how the closure affects them, and how you will handle outstanding orders and warranties.
Finally, bring a tax advisor or attorney in on your plan to ensure compliance with all financial and legal requirements as you close your business, and to help set yourself up for success going forward – whether you’re opening a new business or taking a step back from business ownership.
For tailored advice or assistance with your business closure, contact us to guide you through the process.