There are many reasons small business owners decide to close their businesses: cash flow difficulties, too much competition, the economy, retirement, or wanting to move on to another opportunity. Whatever the reason, having a thorough plan for business dissolution is just as important as it was to follow your business startup plan. Here’s a breakdown of what you need to know about the business dissolution process, sorted by legal entity, and how to wrap things up without landing yourself in hot water.
Sole Proprietorship and Partnership Dissolution
Some business structures are less complicated to start and close. Closing a sole proprietorship or partnership is relatively straightforward, which is helpful if you want to close a business by year’s end.
Sole proprietors and partners in a partnership have no separation from the company regarding legal and financial liability, so there isn’t much more to do beyond letting customers and vendors know about the closure. Still, it’s crucial to have a business closure checklist to ensure any loose ends are tied up.
- Ask a professional. Let your attorney and accountant know when you’d like to close the business and ask what tasks need to be accomplished to make the dissolution go smoothly.
- Get partner approval. In a partnership, the steps for closing the company should be spelled out in the partnership agreement. Typically, all partners must agree on the dissolution and how the assets and liabilities should be divided among the partners. Also, check for any state regulations regarding partnership closures.
- Notify employees. It’s critical to give employees plenty of notice about the company’s dissolution so they can plan for their futures.
- Review contracts and agreements. Review all contracts with customers, vendors, suppliers, and creditors to ensure no penalties or timelines are involved with ending the contracts early. In addition, it’s crucial to cancel the company’s business license and permits.
- Settle outstanding debts. Finally, any outstanding debts will need to be settled or arrangements made for payments. Usually, the business owners sell off the company’s assets, such as computers and equipment, to settle any debt.
The last step for sole proprietorships and partnerships is to file their final tax returns and inform the IRS to cancel the Business’s Federal Tax ID number. Sole proprietors must file Schedule C (Form 1040 or Form 1040-SR), Profit or Loss From Business, with their Form 1040 for the year they dissolve the business.
A partnership must file Form 1065, U.S. Return of Partnership Income, for the year it ceases operations and reports capital gains and losses on Schedule D (Form 1065). Filers also must check the “final return” box on the form and do the same on Schedule K-1.
Along with their forms, sole proprietors and partnerships may need to file the following:
- Form 4797 (Sales of Business Property) if they sell or exchange property used in their business
- Form 8594 (Asset Acquisition Statement) if they sell their business to another party
- Schedule SE (Form 1040) if they are liable for self-employment tax
By contrast, corporations and limited liability companies (LLCs) are legal entities registered with the state in which they are formed. They are separate entities from the owners and will continue to exist as legal entities (with all the responsibilities attached to them) until they are formally closed with the state.
A C Corp is a legal, taxable entity separate from its owners. Owner/shareholders are considered employees of the corporation and have limited liability in the debts and legal responsibilities of the company.
The state of formation dictates how a corporation is formed and dissolved, so be sure you know your state’s requirements for business dissolution. Following are the typical steps taken to close a corporation.
- Ensure the corporation is in “good standing.” Before dissolving a corporation, the company must be in good standing, which means it has kept up with all its ongoing compliance obligations—state taxes, corporation filings, etc. The state may require the corporation to repair its good standing before it can be dissolved.
- Vote for dissolution. Corporate bylaws serve as the company’s ground rules for operating the business, including how the company will be dissolved. Usually, the corporation holds a meeting and has a formal vote to close the business. The vote should be documented in the meeting minutes and signed by all voting board members. If shares of stock have been issued to shareholders, two-thirds of the voting shares must agree on closing the business.
- File Articles of Dissolution. Once the decision to close has been made, the corporation must file Articles of Dissolution (also called Certificate of Termination or Certificate of Dissolution) with the state. Typically, the dissolution form is filed through the Secretary of State’s office.
- Notify creditors, vendors, and customers. Some states require corporations to notify creditors and vendors about the closure before they file Articles of Dissolution. In addition, some states require corporations to publish notice of the dissolution in a newspaper or other publication by a specific date. Also, the corporation should cancel any business licenses and permits.
- Settle outstanding debts. Again, any outstanding obligations must be settled, or arrangements made for payments.
- Tax requirements. Besides filing a final Form 1120, U.S. Corporation Income Tax Return, the corporation is responsible for filing and paying its final payroll taxes, including state unemployment insurance (SUT) and state income tax (SIT). Corporations must also issue final W2s to employees.
- Sales taxes. Corporations that collect and file sales taxes must submit final state sales tax forms and payments—and local sales taxes, if applicable.
After a corporation has paid final debts and taxes, owners can divide the remaining money and property among its owners, per the corporation’s bylaws.
An LLC is a business structure regulated by state statute. The LLC protects its owners from personal responsibility for the company’s debts or liabilities without the formalities required in a C Corp. Owners of an LLC are called members.
Like the dissolution of a C Corp, closing an LLC requires following the steps decreed by the state in which the LLC was formed. Likewise, the actions follow the same path as a C Corp.
- Ensure the LLC is in good standing.
- Hold a vote with the members. Depending on state regulations and the rules outlined in the LLC operating agreement, dissolution approval may require a majority vote or unanimous consent.
- File LLC Articles of Dissolution with the state. Filing dissolution paperwork should automatically cancel the legal business name in the state; however, more steps might be required to cancel a fictitious business name (a.k.a. DBA).
- Notify creditors, vendors, and customers. Again, business owners should determine if notification must be made before filing the Articles of Dissolution. Also, licenses and permits should be canceled.
- File the LLC’s taxes. How the LLC usually files taxes determines how the LLC will file its final taxes.
- Pay final payroll and sales taxes.
As with a C Corp., once all debts have been paid, the LLC may distribute any remaining assets to the members.
For most business owners, there is plenty of time to wrap up a business before the year’s end. As long as you follow the proper procedures dictated by your state, you should be able to enter the new year with a fresh start.
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