What You Need To Know About Taxes
📚 Shutting down a small business involves more than just locking the doors. You still have tax and legal responsibilities to handle as you wind things down. This includes filing final tax returns and meeting payroll obligations.
📃Income Tax Requirements
What you need to do regarding federal income tax depends on how your business is structured.
💰Sole Proprietorships and Single-Member LLCs: If your business operates as a sole proprietorship or a single-member limited liability company (LLC), closing it down is relatively straightforward. All the federal income tax implications of closing your business will be accounted for on your personal tax return. When we prepare your tax return, we’ll indicate that it’s the “final return.”
Any federal income tax gains or losses from selling or abandoning business assets should be reported on your personal tax return. This is because, under federal income tax rules, a sole proprietorship is considered as if you, as an individual taxpayer, directly own all the business assets.
💰Pass-Through Entities: If your business operates as a pass-through entity, such as a partnership, an S corporation, or a multi-member LLC treated as a partnership for tax purposes, you will likely arrange for the entity to sell assets, possibly abandon some assets, and liquidate. This will trigger tax consequences at the entity level that will pass through to the owner(s) and be reported on their individual tax returns.
Each owner must receive a Schedule K-1 to report their share of income, deductions, and credits from the entity. These tax items are then reflected on each owner’s personal tax return (Form 1040). Gains and losses from selling business assets must be reported on the pass-through entity’s return (Form 1065 or Form 1120S). You also need to report any net self-employment (SE) income from the closed or closing business and calculate any SE tax due.
Additionally, a pass-through business entity must file a final federal income tax return and issue related K-1 schedules to you and the other owners for the year it closes. An S corporation must also file additional IRS forms if the corporation adopted a resolution or plan to dissolve or liquidate any of its stock.
💰C Corporations: If your business has operated as a C corporation, you will probably arrange for the corporation to sell assets, possibly abandon some assets, and liquidate. This will result in tax consequences at the corporate level and also for you personally due to the deemed sale of your stock in exchange for liquidating distribution from the corporation. These tax consequences must be reported on the corporation’s final federal income tax return (Form 1120) and on your personal Form 1040.
📌Important: Regardless of your business type, you must notify the IRS about the closure of your business by sending a letter with the following information: the business name, the business address, and your Employer Identification Number (EIN). If you owe federal income tax after closing your business but can’t pay, there may be options like an installment payment agreement, an offer in compromise (OIC), or a delay in collection activities. The IRS will then cancel your EIN.
📃Other Tax Considerations
When closing your business, it’s not just income taxes that you need to consider. If your business has employees, you must pay any final wages and compensation owed to them. You’ll also need to file any necessary final federal payroll tax returns and make any required final federal payroll tax deposits.
This includes the Federal Insurance Contributions Act (FICA) tax, which has two parts:
💡Social Security tax: The Old Age, Survivors, and Disability Insurance (OASDI) portion is taxed at a rate of 6.2% on the amount up to an annual wage base. The 2023 base is $160,200, adjusted for inflation.
💡Medicare tax: The Hospital Insurance (HI) portion of the tax is 1.45% on all wages, with no wage base.
📣Both employers and employees are responsible for paying their share of FICA tax. Employers must also withhold employees’ shares from their paychecks and deposit unemployment taxes while filing the appropriate tax forms.
Likewise, employers must provide employees with their final W-2 wage income statements and send copies to the IRS by the due date of the final quarterly payroll or annual payroll tax deposit. If your business paid more than $600 in its final tax year to an independent contractor, you must provide the worker and the IRS with the necessary tax form (1099-NEC).
There may be other tax considerations related to closing your business, such as how to handle:
- Debt cancellation transactions
- Deductions for suspended passive activity losses from prior years
- Recapture of depreciation deductions
- Bankruptcy issues, if applicable
Additionally, if your business has a retirement plan for employees, you need to terminate the plan and distribute the final amounts to participants as required. Terminating a plan involves meeting detailed notice, funding, timing, and filing rules. Complicated requirements may also apply if you offer a Flexible Spending Account (FSA), Health Savings Account (HSA), or similar program to employees.
📃Records Retention
There’s no fixed timeframe for how long you should keep tax records for a closed business. However, at a minimum, you should retain them for the statute of limitations for the final period. Typically, the IRS has three years from the due date of the final return to inspect it, impose additional tax, or conduct an audit. This is also the timeframe for you to amend your return if needed.
📃Need more help?
📞Taxes related to closing a business can be complicated. Contact your accounting advisor at Zara Financials for help navigating the process smoothly. We’re here to answer your questions!
