Small business owners were especially hit hard during the COVID-19 outbreak. Even in areas where restrictions have loosened up, many are still struggling to survive. A recent report from the Federal Reserve Bank estimates that nearly 30% of U.S. small businesses will shut their doors for good if they don’t receive additional assistance from the government. Although it is never an easy decision to permanently close a business, certain tax responsibilities must be met before you can call it quits.
Tax Responsibilities When Closing a Business
Closing a business is often challenging. Thankfully, the IRS provides free resources to help you navigate the process on their “Closing a Business” webpage. The following is a brief overview of the federal tax responsibilities discussed on that page.
1. File Your Final Return & Related Tax Forms
The year that you close your business, you must file a final tax return. The type of return and related forms will vary depending on your business structure.
Sole Proprietor – File Schedule C (Form 1040 or Form 1040-SR), Profit or Loss From Business, with your individual tax return.
You may also need to file the following forms:
- Form 4797, Sales of Business Property, for each year you sell or exchange property used in your business. You also need to file this form if closing your business causes the business use of an eligible property under Section 179 to drop to 50% or less.
- Form 8594, Asset Acquisition Statement, if you sell your business.
- Schedule SE (Form 1040), Self-Employment Tax, if you have net earnings of $400 or more from your business.
Partnership – You must file Form 1065, U.S. Return of Partnership Income, for the year you close your business.
When you file, you must:
- Report capital gains and losses on Schedule D (Form 1065).
- Check the “final return” box (near the top of the front page).
- Check the same box on Schedule K-1, Partner’s Share of Income, Deductions, Credits, Etc.
You may also need to file these other forms with your Form 1065:
- Form 4797, Sales of Business Property, for each year your partnership sells or exchanges property used in the business. You also need to file this form if closing your business causes business use of an eligible property under Section 179 to drop to 50% or less.
- Form 8594, Asset Acquisition Statement, if you sell your business.
Corporation – You must file Form 966, Corporate Dissolution or Liquidation, if you adopt a resolution or plan to dissolve the corporation or liquidate any of its stock.
You must also file your corporation’s final income tax return. Be sure to check the “final return” box, which is near the top of the front page.
For a C corporation you must:
- File Form 1120, U.S. Corporate Income Tax Return, for the year you close the business.
- Report capital gains and losses on Schedule D (Form 1120).
For an S corporation you must:
- File Form 1120-S, U.S. Income Tax Return for an S Corporation for the year you close the business.
- Report capital gains and losses on Schedule D (Form 1120-S).
- Check the “final return” box on Schedule K-1, Shareholder’s Share of Income, Deductions, Credits, Etc.
Regardless of the type of corporation, you may also need to file these forms when you file your Form 1120 or 1120-S:
- Form 4797, Sales of Business Property, for each year you sell or exchange property used in the business. You also need to file this form if closing your business causes the business use of an eligible property under Section 179 to drop to 50% or less.
- Form 8594, Asset Acquisition Statement, if you sell your business.
2. Take Care of Employees
You must pay all employees their final wages and any compensation owed. Additionally, you’ll need to make your final federal tax deposit and report employment taxes.
To report employment taxes, the following forms may be required:
- Form 941, Employer’s Quarterly Federal Tax Return, or Form 944, Employer’s Annual Federal Tax Return, for the quarter in which you make final wage payments. Be sure to check the box to notify the IRS that your business is closed and enter that date when final wages were paid. You’ll also need to attach a note which includes the name and contact information of the person responsible for your payroll records.
- Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, for the calendar year in which you paid final wages. You’ll need to check box “d” to indicate this is your final form.
Don’t forget to provide a Form W-2, Wage and Tax Statement, to every employee for the calendar year in which you pay them their final wages. If they receive tips, you’ll also need to file Form 8027, Employer’s Annual Information Return of Tip Income and Allocated Tips.
3. Pay Your Taxes
You’ll be responsible for paying any taxes owed. If you are unable to pay in full, you may be able to make monthly installments by applying for a payment plan. Depending on your financial situation, you may also be eligible for an Offer in Compromise, Currently Not Collectible status, or other tax relief.
4. Report Contractor Payments
If you paid any contractor $600 or more during the calendar year in which you shutter your business, you must report those payments using Form 1099-NEC, Nonemployee Compensation. You can use Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to send paper copies of all Forms 1099 to the IRS.
5. Cancel Your EIN
One of the final tax responsibilities when closing a business is to cancel your employer identification number (EIN) and close your IRS business account. You can do this by sending a letter to the IRS with the following information:
- The legal name of the business
- Business EIN
- Your business address
- The reason for closing your account
If you have a copy of the notice sent to you when you were assigned your EIN, be sure to include it, as well. Your cancelation letter and original EIN notice should be mailed to:
Internal Revenue Service, Cincinnati, OH 45999
Please note that the IRS will not close your business account until you have filed all required tax returns and paid all taxes owed.
6. Keep Your Tax Records
You should keep all business property records until the period of limitations expires for the year in which you dispose of the property. The period of limitations is the time in which you can amend your tax return to claim a credit or refund, or the IRS can assess additional tax.
For employment tax records, be sure to hang on to those for a minimum of four (4) years.
Need Help?
Although the IRS provides ample guidance for dealing with your federal tax responsibilities when closing a business, you’ll also need to deal with your final state tax returns, as well. All of this can get a bit overwhelming for most people, so we strongly recommend seeking assistance from an experienced tax professional to ensure everything is done correctly and on time. To schedule a free consultation with Tax Defense Network, simply call 855-476-6920 today!