What Happens with Taxes When You Close a Business?

While owning and operating your own business has the potential to be a profitable venture, it doesn’t always work out this way. If you have to close your business, there are potential tax implications that come with closure.

Small business owners need to fulfill their filing requirements to avoid greater tax liabilities and penalties in the future. Business tax laws will depend on your state and city. To avoid any unforeseen costs and penalties, consult a tax lawyer before you wind up your company.

Tax Implications of Closing Your Business

No matter what type of business you have, there are tax rules that you will need to address. Depending on the type of business you have, the process can be relatively simple to complex and lengthy.

“There are many issues related to the closing of a business, but from a tax perspective, the most important is making sure you’ve taken care of any trust fund taxes that might exist,” says Steve Dimengo, a tax attorney at Buckingham, Doolittle & Burroughs in Akron, Ohio.

“Those are liabilities like sales taxes that should have been collected or were collected and haven’t been remitted. You may also have liability for taxes concerning your purchases if you have a direct-pay permit. The other area that comes up a lot is whether employee withholding taxes are withheld from wages.”

Because of the potential for complexity, it is important to start addressing your potential tax liabilities as soon as possible. This will prevent you from facing a large debt at the end of the tax year.

Closing Your IRS Business Accounts

One of the most important things you must do is notify the Internal Revenue Service (IRS) know you are closing your business. You can do this by canceling your employer identification number (EIN) and closing your IRS business account. To do so, you must send a letter to the IRS containing specific information.

• The complete legal name of the business
• The business address
• The business EIN
• The reason you want to close the account

If you also have the original letter the IRS sent when it assigned your EIN number, include a copy with your cancellation notice. The IRS will not close your account until you have filed all required returns and paid all outstanding tax debt.

Filing a Final Sales Tax Return

If a business has collected sales tax in a state, it must file a “final return” in that state. Depending on the state, you might be able to file this final sales tax return when you close the business.

Other states may require waiting until the annual sales tax due date. This is a must, as failing to pay the sales tax you collected can result in interest charges, penalties, and even criminal charges.

Paying Outstanding Tax Debts and Back Taxes

If you owe federal or state taxes, you won’t be able to close your business with them. Both the IRS and state governments require payment in full of all outstanding tax debts before they close a business account. If you can’t afford to make a single full payment, consider requesting a payment plan or negotiating a lower payoff amount.

“If the company owes unpaid income taxes and just doesn’t have the assets to pay them, the IRS will put the company into what’s called not collectible status. The liability doesn’t go away,” says David C. Gair, a tax attorney at Troutman Pepper Locke in Dallas, Texas.

Sale of Assets

If your business has assets, you will need to do something with them when closing your business. How you handle these assets can have an impact on your tax liability. If you transfer ownership to a friend or family member, gift or inheritance tax liabilities could exist. The sale of business property and assets could result in a taxable gain or loss.

Because several factors determine the amount of tax owed, it is best to speak with a tax professional before selling business assets. They will help you calculate the asset’s “tax basis” to determine value with depreciation. That way, you know what sale price would be considered a profit vs. a loss. If you sell the assets at a loss, you cannot assume that you can offset profits with this loss. This is another area where a tax professional can help you determine tax liability.

Gair explains that selling a company’s assets can help you avoid potential criminal tax liability. “To the extent that the company has assets, what you need to do is liquidate everything and pay the IRS the money that you get from liquidating it. That’s how you stay clear of problems.”

Reporting Employee Taxes

A business with employees must report employment taxes and payroll tax deposits to those employees. This includes filing any applicable quarterly or annual payroll tax returns and the final wage W2 form with the IRS.

Any payments over $2,000 made to contract workers must also be reported to the IRS. Once the business issues final wages, it needs to make final federal tax deposits and report employment taxes to the IRS. Even though the business will no longer be in operation by the time annual taxes are due, the business must still send W-2 forms to all employees.

If your business has a benefit or pension plan for employees, it must also address these. This could include terminating pension or retirement plans and closing health savings accounts. Some health plans can have tax consequences, so employers need to address these issues for employees. For example, health savings accounts are a tax-favored health plan that requires reporting.

Closing a C-Corporation

When closing a C-corporation, distributions are typically made to the shareholders. However, this results in double taxation.

A C-corporation must pay taxes as an independent entity. The shareholders who receive distributions must also pay taxes. 

Closing an S-Corporation

An S-corporation is treated as a “pass-through” organization for tax purposes. This means that the individual who owns the company will report its profits and losses on their tax return. However, this is not the case when you close the business and liquidate its assets. Then, an S-corporation is treated like a C-corporation.

When you’re selling your business, and you’re a pass-through entity — which could be a partnership, limited liability company, or an S corp — you want to make sure your sale price is allocated to something that produces a capital gain.

Closing an LLC

The tax liability of an LLC is treated as a “pass-through” for the LLC’s shareholders. If the LLC has only one owner, it is the same as a sole proprietorship.

Unlike an S-Corp, this treatment doesn’t change when the business closes. Each shareholder of the LLC will claim their share of the assets, gains, and losses.

Closing a Nonprofit

Even though nonprofits generally don’t make income tax payments, they still need to file a tax return. When dissolving, the nonprofit’s assets must be distributed to another tax-exempt entity.

Steps To Close Your Business and Resolve Tax Issues

How you decide to close your business will depend on your type of organization. Sole proprietors and single-person-owned LLCs can make the decision independently. Partnerships, multi-party LLCs, and businesses may have other requirements. These are typically listed in the articles of organization.

The next step is to file dissolution documents to dissolve your business legally. Failing to do this will legally keep your business open, exposing you to future legal and tax filing requirements. Cancel any licenses, permits, and registrations that the business may have. During this time, start the liquidation of business assets and pay final wages. Ensure that you follow any applicable labor laws. This will typically include issuing final payroll and employment tax returns.

Notify the IRS of the business dissolution and cancel your Employer Identification Number (EIN). The state and IRS will not approve your business cancellation until you satisfy your tax liability. Because of this, you will need to confirm that your outstanding tax debts are paid before you submit your request. This typically means waiting until you file your final federal income tax return.

Once you finish closing your business, keep all of your records. You will need to keep operating documents, tax records, and employment records. Depending on the type of records, you may need to keep them for the next three to seven years.

Gair explains the importance of keeping the records from a closed business. “The general rule is that you’d want to keep your records for a minimum of three years. If there’s been a gross underreporting, the IRS has the ability to go back six years. I would generally tell people to keep them for about seven years as a good general rule.”

Common Mistakes To Avoid When Closing a Business

Small business owners commonly commit the same mistakes when closing down their businesses. One of which is ignoring or neglecting their outstanding debts and tax liabilities. Just because you close the business does not mean these financial responsibilities go away.

Even if you do not currently owe any taxes, additional tax obligations may arise after you file your final tax returns. Many business owners make the mistake of not filing their final tax returns. Both federal and state law require business owners to file a tax return to wrap up taxes owed.

Even if you pay all business taxes, many small business owners forget to notify the state and IRS that the business is closed. This can unintentionally violate a state law that requires such notification.

Another common mistake is not keeping proper business records. Many small business owners assume that because they no longer have the business, they don’t need to keep the records. In contrast, you should keep business records for tax purposes. Keeping them for at least four more years after making your final federal tax deposits is also good practice.

Getting a Tax Lawyer for Closing a Business

Speaking with a tax professional when closing your business can have several benefits. Because the requirements can be specific depending on your business type, a certified public accountant (CPA) or tax attorney can ensure you comply with the law.

If your business owes back taxes, your tax lawyer will assist with addressing this debt. Otherwise, filing your final federal tax return won’t be enough to close your business.

Find Experienced Legal Help

If you own a business and are considering closing it, speak with a tax lawyer. Discuss the current state of your business and potential tax liabilities. Visit the Super Lawyers directory to begin your search for an experienced tax attorney.