Tax considerations for shutting down a business

Closing your company can be a demanding and difficult undertaking. The IRS provides resources to assist you. In this situation, you’ll need to follow to close your business from a federal tax standpoint, regardless of the sort of business you own, as well as information to assist you in taking care of your employees. Whether your business is a single proprietorship, a partnership, or a corporation, the information on this page will assist you in determining what to file and how to record income and expenses before closing. When closing a business, remember to check your state’s obligations.

Tax implications are determined by the business structure 

When a business closes, its tax classification has major tax implications. Each of the three main business structures has an impact on how the closing is handled for tax purposes:

  • If you ran your firm as a sole proprietorship or a single-member (one-owner) limited liability company (SMLLC), the federal income tax consequences of closing it will be shown on your personal tax return.
  • If the company was run as a pass-through entity, such as a partnership, an LLC handled as a partnership for tax reasons, or an S corporation, you’ll probably need to sell assets, abandon some assets, and liquidate it. If this is the case, the entity would incur tax losses that will be passed on to the owners and accounted for on their individual tax returns. In other words, both the pass-through corporation’s (Form 1065 or Form 1120S) and your personal tax returns will have to account for the tax consequences (Form 1040).
  • If the company was run as a C corporation, you’ll most likely arrange for asset sales, maybe asset abandonment, and liquidation. In this situation, the deemed sale of your stock in return for the corporation’s liquidating payout will result in tax losses and maybe gains at the corporate level, as well as a tax gain or loss at the individual level. As a result, there will be tax implications that must be reported on both the corporation’s federal income tax return (Form 1120) and your personal Form 1040.


Reporting Losses, Gains, and Other Items

Gains and losses resulting from the sale or abandonment of business assets are reported as federal income tax gains and losses on your personal tax return. This is because the federal income tax regulations disregard the presence of a sole proprietorship or SMLLC that is classified as a sole proprietorship for tax purposes. As a result, all business assets are regarded directly owned by you (as an individual taxpayer).

Gains

When the sale price of an asset exceeds its tax basis, you have a tax gain. The tax basis of an asset is usually equal to its original cost minus any depreciation or amortization deductions.

Gain attributable to earlier depreciation deductions for real estate held for more than one year is now taxed at a maximum federal rate of 25%. Gain due to previous depreciation or amortization deductions is taxed at higher ordinary income rates for other depreciable or amortizable assets (such as furniture, equipment, acquired software, and purchased intangibles) (up to 37 percent under current law).

Long capital gains rates are normally applied to any leftover gain from real estate and depreciable or amortizable assets held for more than a year. Gains on the sale of receivables, inventory, and other assets held for less than a year are taxed at a higher ordinary income rate.

Losses

If the asset’s sale price is less than its tax basis, you’ve made a tax loss. In principle, current tax legislation allows you to fully deduct an overall net loss from selling business assets from other income.

C Corporation Concerns – If you’re shutting a C corporation, you’ll most likely arrange for the corporation to sell assets, relinquish some assets, and liquidate. If that’s the case, the corporation will face tax losses and maybe gains, as well as a tax gain or loss on the deemed sale of your stock in exchange for the liquidating distribution you receive from the corporation. As a result, there will be tax implications that must be represented on both the corporation’s final federal income tax return (Form 1120) and your personal Form 1040.

Furthermore, for the year in which it shuts, your pass-through company organization must file a final federal income tax return and distribute K-1 schedules to you and the other owners. If the corporation issued a resolution or plan to dissolve or liquidate any of its stock, the company must file extra IRS papers.

Other Tax-Related Issues

You got an Employer Identification Number (EIN) when you formed your business entity, which was utilized to identify the company for federal tax purposes. If this is the case, you must cancel your EIN and close your IRS business account. The IRS will not cancel your account until you have filed all required returns and paid all taxes. Contact your tax professional for assistance in covering all of your bases.

Your tax advisor can also assist you with a variety of other concerns relating to the closure of your business, including as:

  • Paycheck Protection Program (PPP) loans and their tax treatment
  • How debt cancellation transactions are taxed
  • Deductions for losses from halted passive activity in previous years
  • Depreciation deductions are reclaimed, and
  • Bankruptcy, if necessary.

It’s also critical to maintain tax-related records after your business closes in case of an audit. Property records should be retained until the later of the dates listed below:

  • The deadline for requesting a credit or refund on your federal tax return has gone, or
  • The deadline after which the IRS can no longer charge you with additional tax for the year you sold the property.

Maintain tax records for at least four years. Your tax advisor can provide guidance on how long to keep other data, such as tax returns. Your tax expert can assist you in completing the necessary forms to record gains and losses, as well as any business income and deductions, for the final year of operation.