When you go out of business, your tax obligations are your most important debts to repay, because governments are given extraordinary legal powers to collect back taxes. In addition, you are personally liable for some tax debts, such as payroll taxes, even if your business is a corporation or LLC. So before you pay off even one trade creditor, make sure you've met of all your tax obligations, as discussed below.
First and most important, if you have employees, make your final payroll tax deposits and file all of your final employment tax paperwork on time. First priority should go to federal taxes withheld from employees' paychecks—income tax withholding and Social Security and Medicare taxes. Next in line are state income withholding taxes and sales taxes that you have collected. (When you file the final sales tax forms, be sure to write FINAL across the top of the return.) With these serious tax obligations behind you, it's time to take care of the employer's share of the Social Security and Medicare taxes. For more information, see our article on prioritizing business debts to repay.
Negotiate with the IRS. If you owe the IRS more than you can pay, you might be able to pay less than you owe through an offer in compromise or installment payments. To start the offer in compromise process, fill out IRS Form 656, Offer in Compromise. To obtain an installment payment plan with the IRS, use Form 433A, Collection Information Statement. For more information on the advantages and disadvantages of each, as well as how to calculate the amount you should offer to pay, see Stand Up to the IRS, by Frederick W. Daily (Nolo).
There are a number of IRS requirements you need to take care of when ceasing business operations; similar state requirements apply as well. Because tax requirements can get complicated in a hurry, consider enlisting the help of a tax professional, especially if your business makes over $50,000 per year or has several owners.
Sole proprietors. As usual, report your income and expenses, including information on gains or losses, on Schedule C of your Form 1040. File your return by April 15 the year after you close your business. There is no "final return" box to check on Schedule C.
Partnerships and LLCs. File Form 1065, U.S. Partnership Return of Income, and check the box that says this is your final return. Also report any profits or losses allocated to each partner for the year by filing Form 1065 (Schedule K-1), Partner's Share of Income, Credits, Deductions, etc. File both forms by April 15 the year after your partnership closes.
Corporations. C corporations should file Form 1120, U.S. Corporation Income Tax Return, and check the box that this is their final return. S corporations should file Form 1120S, U.S. Corporation Income Tax Return for an S Corporation, and check the box that this is their final return. Also report any income allocated to each S corporation shareholder by filing Form 1120S (Schedule K-1), Shareholder's Share of Income, Credits, Deductions, etc. Corporations also need to file IRS Form 966, Corporate Dissolution or Liquidation, to report their dissolution. You need to file these forms two months and 15 days after your tax year ends—that is, two months and 15 days after you close your business.
Reporting asset sales. You will experience a taxable gain or loss when you liquidate your business's assets. You'll need to file Form 4797, Sales of Business Property, to calculate your gain or loss. After calculating the gain or loss on this form, you record the total from this form on your personal or corporate income tax return, depending on your form of business. (For more information, see IRS Publication 544, Sales and Other Dispositions of Assets.)
If you had employees or independent contractors working for you, you'll also need to take the following steps. This also applies if you were the sole employee of your corporation.
Employer returns. File your final employer's federal tax return, IRS Form 941 or 944, and your final federal unemployment tax return, IRS Form 940 or 940EZ, by their regular due dates. Mark the returns as final and include the proper amount of taxes. You must attach to both of these forms a statement showing the name of the person who will be storing the payroll records for the business and the address where the records will be kept. Also, don't forget to file your state's version of the wage and withholding report.
Withholding statements. Issue final wage and withholding information to your employees on Form W-2, Wage and Tax Statement, by January 31 of the year after your business closes. Report the information from the W-2s to the IRS using Form W-3, Transmittal of Income and Tax Statements. (If you were in the restaurant business, you must also file information on tip income with Form 8027, Employer's Annual Information Return of Tip Income and Allocated Tips.)
Contractor statements. Issue payment information to freelancers and contractors using Form 1099-MISC, Miscellaneous Income. Report the information from the 1099s to the IRS using Form 1096, Annual Summary and Transmittal of U.S. Information Returns, (unless you file the 1099-MISC forms electronically).
Pension plans. If you provided your employees with a pension plan, you'll need to close it down. If the plan was a simplified employee pension (SEP) plan, simply notify the financial institution running the plan that you won't be making any more contributions. If you had a savings incentive match plan (SIMPLE), you need to wait until the end of the year to shut it down. Legally, you are required to continue to fund the plan until the end of the year.
You won't need your business ID numbers anymore, so take steps to cancel them.
Federal employer identification number. The IRS will not cancel your EIN, but if you no longer need the number for your business, the IRS will deactivate your business account (and reactivate it if you ever go back into business). To deactivate your account, write to the IRS at: Internal Revenue Service, Cincinnati, OH 45999 and say that you're going out of business and want to close your account. If you have the EIN Assignment Notice that was issued when your EIN was assigned, include a copy of it when you send your letter. Otherwise, be sure to include the complete legal name of your company, your name, the EIN, and the business address. You must file all tax returns due before the IRS will close your account.
State employer tax ID number and business tax account. To close your state tax account, contact your state tax agency. Some state agencies have a notice of discontinuance form that you must file; in other states you have to write a letter to the tax agency. Most state tax agencies have clear instructions for what you need to do on their website. You must file all tax returns due before a state tax agency will close your account.
You would be well advised to hire a tax preparer or accountant to file your final tax forms for you. It saves you the headache of preparing them yourself, ensures their accuracy, and will no doubt gain you some deductions for business losses that you can take against other income you or your spouse bring home. After you've wrapped up all of your tax paperwork, the IRS recommends that you keep tax records for seven years after closing your business. If youre worried about your tax obligations, or you can't pay your payroll taxaes, speak to a local tax lawyer immediately.