Closing a Business
Many businesses have been forced to shut their doors due to the COVID-19 pandemic. Permanently closing a business can be both administratively challenging and emotionally draining, with various legal and tax obligations to consider. If you’re thinking about closing your business, or have already started the process, we’re here to assist you in any way we can. This letter outlines the steps required to close your business and summarizes the kinds of information we’ll need to help you.
1. File a Final Return
Your business must file a final tax return for the year it closes. Of course, the type of return required depends on the type of business you have. For example, if you’re a sole proprietor, you’ll file Schedule C with your Form 1040 or Form 1040-SR for the year you close your business. If you have net earnings of $400 or more from your business, you’ll also file Schedule SE to report your self-employment tax.
If you operated your business as a partnership, or as an LLC treated as a partnership for tax purposes, the entity will file a final Form 1065. It will check the “final return” box located near the top of the front page of the return. Similarly, the “final K-1” box should be checked on each partner’s Schedule K-1, which reports that partner’s share of income, deductions, and credits from the entity.
If you operated your business as a corporation, the entity must file Form 966 if it adopted a resolution or plan to dissolve or liquidate any of its stock. It also will file a final Form 1120 (if classified as a C corporation) or Form 1120-S (if classified as an S corporation) with the “final return” box checked at the top of the front page. If you operated your business as an S corporation, the “final K-1” box should be checked on each shareholder’s Schedule K-1.
Other forms may need to be filed with the IRS as well, including the following:
1. Form 4797, if property used in your business is sold or exchanged, or the business use of certain eligible property drops to 50% or less.
2. Schedule D, to report capital gains and losses.
3. Form 8594, if you sell a group of assets that makes up a trade or business.
2. Take Care of Employees
This involves paying employees any final wages and compensation owed. Also, you have to make final federal tax deposits and report employment taxes. This step is crucial because if you don’t withhold or deposit employee income, Social Security, and Medicare taxes, the trust fund recovery penalty may apply.
To properly report employment taxes, file the following forms:
1. Form 941 or Form 944 for the quarter in which final wage payments are made. There’s a box on the form indicating that the business has closed, and the date final wages were paid must be entered. Also, a statement must be attached to the return showing the name of the person keeping the payroll records and the address where those records will be kept.
2. Form 940 for the calendar year in which final wages were paid. The form must show that this is the final return of the business.
3. Form W-2 for the calendar year in which final wages were paid. This form should be provided to employees by the due date of the final Form 941 or Form 944. (Employees generally receive copies B, C, and 2 of Form W-2.) Also, file Form W-3 to transmit copy A of Form W-2 to the Social Security Administration.
4. Form 8027, if your employees received tips.
In addition, if your business has a retirement plan for employees, you’ll want to terminate the plan and distribute benefits to participants. There are detailed notice, funding, timing, and filing requirements that must be met by a terminating plan. There also are complex requirements related to flexible spending accounts, health savings accounts, and other similar programs for your employees. Please contact us for more information.
3. Report Payments to Contractors
If you paid any contractors at least $600 for services (including parts and materials) during the calendar year in which you close your business, you must report those payments on Form 1099-NEC. Form 1096 is used to send paper copies of all Forms 1099 to the IRS. Some businesses must file Forms 1099 electronically.
4. Pay Any Tax Due
If you owe taxes after closing your business, there are various payment methods available. If you can’t afford to pay your taxes, we can help you pursue an installment agreement, offer in compromise, or a temporary collection delay. Fortunately, the IRS recognizes that many taxpayers are struggling due to the COVID-19 emergency. That’s why the agency has introduced its new “Taxpayer Relief Initiative,” which is designed to help struggling taxpayers impacted by COVID-19 more easily settle their tax debts. For example, certain qualified individuals who owe less than $250,000 may set up installment agreements without providing a financial statement or substantiation if their monthly payment proposal is sufficient. Contact us for more information.
5. Cancel Your EIN
When you set up your business, the IRS assigned it an Employer Identification Number (EIN), which was used to identify the business for federal tax purposes. You will need to cancel the EIN and close your IRS business account. To do so, send a letter to the IRS that includes (1) the complete legal name of the business, (2) the business’s EIN, (3) the business’s address, and (4) the reason you wish to close the account. If you still have the notice from the IRS that assigned your business an EIN, include a copy of that notice with your letter. The letter should be sent to the IRS office in Cincinnati, OH 45999.
Note: The IRS won’t close your business account until all necessary returns have been filed and all taxes have been paid.
6. Retain Records
After you close your business, you will need to retain business records. The length of time you need to keep your business records depends on what’s recorded in each document. Generally, keep records relating to property until the period of time expires during which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax for the year in which you dispose of the property. Keep all records of employment taxes for at least four years. We can answer any questions you may have about retention of various kinds of tax returns and records.
7. Watch out for Other Tax Issues
We can assist you with many other complicated tax issues related to closing your business, including Paycheck Protection Program (PPP) loans, the COVID-19 employee retention tax credit, employment tax deferral, debt cancellation, use of net operating losses, freeing up any remaining passive activity losses, depreciation recapture, and possible bankruptcy issues. There are many special tax rules contained in pandemic-related legislation, and there may be additional retroactive changes in future legislation that could affect your situation, including the deductibility of business expenses paid with PPP loan proceeds.
8. Fulfill Legal Obligations
In addition to the tax steps mentioned above, there are certain legal obligations of which you should be aware. It’s important you consult legal counsel when sifting through these issues.
1. Follow Governing Documents. If the business has multiple owners, all procedures outlined in the entity’s governing documents (like a partnership or LLC agreement) regarding shutting the business down must be followed.
2. File Dissolution Documents. You must legally dissolve the business in each state in which it’s registered. Failure to do so will expose the business to continued state taxes and filing requirements.
3. Cancel Registrations, Permits, Licenses, and Business Names. This is an important step in protecting your finances and reputation. Consult legal counsel for more information.
4.Comply with Employment and Labor Laws. The business may be subject to the Worker Adjustment and Retraining Notification (WARN) Act. Again, contact legal counsel for more information.
We understand there’s a lot to digest here. We would love to set up a time with you to discuss these issues. As always, if there’s anything we can do to help, please don’t hesitate to contact us.