The Tax Consequences of Closing Your Small Business

The possibility of a recession looms large. According to one recent study, approximately 20% of all small businesses that open their doors today will close within the first year. Of the number that survives, about 30% will close just one year later. By year five, about half of those SMBs will have closed.

All of this is to say that if you've tried to open a small business and have had to prematurely close your doors for whatever reason (be it the condition of the larger economy or other concerns), you're not alone. Still, just because you're about to close your doors doesn't mean your obligations as an entrepreneur are formally over.

Case in point: income taxes. Just as was true with starting a business, closing a small business brings with it some essential tax implications that you need to be aware of in the coming year. This is true both for yourself and with regard to the hardworking men and women that you employed along the way.

Overall, the most important thing to understand about this process is that the tax consequences of closing a small business depend largely on exactly what type of organization you're talking about.

If your small business was a C-Corp, for example, you will likely be subject to what is called "double taxation." This means that not only will you be paying taxes on any assets that get distributed to shareholders, but those shareholders will also be taxed on gains on their individual incomes as well.

The situation is a bit different if you're talking about an S-Corp, which is more of a "pass-through" entity when it comes to income tax purposes. This means that any profits or losses will get reported on the tax returns of each shareholder. However, these rules don't apply to any "liquidating distributions" that are made.

In a situation where the business that you're closing is an LLC, things will also operate a bit differently. Here, you're also talking about a company that dealt with "pass-through" income to its shareholders. This was true whether you formed the business as a sole proprietorship or as partnership income. The way taxes are handled will largely continue through until you formally dissolve the business. This means that every member of the LLC will be exclusively responsible for reporting their own income, which includes any share they receive of the company assets that are distributed upon its closing.

Regardless of the type of business that you're closing, one of the most critical obligations that you have will come down to your employees. In no uncertain terms, you need to not only pay them any final wages that they are owed, but you also need to make employment tax payments, too. If you don't, you could be subject to a significant penalty that, since you are already in the process of closing your business, it would be in your own best interest to avoid.

In addition to paying all the taxes that you still owe (which your small business accounting professional should be able to help you take care of), you'll also need to report any payments that you've made to contract workers along the way. Don't forget that if you have paid independent contractors at least $600 for their services throughout the course of the year, you need to report those payments to the Internal Revenue Service.

Finally, you'll want to cancel your employer identification number (EIN) and close your business account with the IRS. To do this, you need to send a letter that includes several important pieces of information, including the complete legal name of the business that you're closing, its address, the business EIN that you've been using up to this point for tax purposes, and the reason why you are now in the process of closing the account. Obviously, the reason will come back to the fact that you're shutting down the business in general, but this all still needs to happen by way of a formal process so that there are no issues in the future.

In the end, closing a small business is certainly an unfortunate situation to find yourself in - but it's critical to understand that this is one journey you do not have to make alone. Countless people find themselves in a similar situation on a daily basis and so long as you take the lessons that you've learned along the way with you, there is truly no limit to what you may accomplish moving forward.

If you have any additional questions about the tax consequences of closing your small business, or if you'd just like to speak to someone about your own situation in a bit more detail, please don't delay - contact us today to speak with an accounting professional directly.