Dissolving Corporations: Steps, Tax Consequences, and Liquidation

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Brendan Tuytel

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December 15, 2023

This article is Tax Professional approved

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There are many reasons why you may need to dissolve a corporation. While the decision to dissolve can be difficult in itself, we’re here to make the process of dissolving a little bit easier.

From the individual steps to the tax consequences and implications of the decision, below is a guide on what you need to know to start tackling the process.

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Dissolving a corporation in 9 steps

Step 1: Get approval from the company owners

To dissolve a corporation, the process starts with owner approval.

For C corporation, S corporation, or LLC (limited liability company or limited liability corporation), this typically involves a majority vote from shareholders or members. However, the definition of a 'majority' varies by state. Often, it requires more than a simple majority, possibly up to two-thirds of votes, depending on state laws and the company’s charter or bylaws. In corporations, a vote with the board of directors pushes the decision forward. This vote must be on the record. For LLCs, dissolution procedures are usually specified in the operating agreement. If not, state LLC laws apply, which may have different requirements for the dissolution vote. Remember, state-specific rules and provisions in your company’s documents can significantly influence this process​.

Step 2: Notify customers and employees

Once the decision has been made, it’s time to notify the people who are going to be affected.

If possible, provide a timeline so everyone knows when business operations will cease. Once you’ve filed for dissolution, you can no longer conduct business so close off all operations before you file the forms.

For your customers, take time to review any outstanding accounts receivables to make one final push on collections. If you have any ongoing projects or orders, be sure to tie up these loose ends or, if the dissolution means you can’t close them off, work together to find a compromise.

For your employees, clarify when their shifts will end and when the final payroll cycle will be run.

Step 3: File a certificate of dissolution with the state

Corporations are formed at the state level so the formal dissolution process begins there.

You need to contact the Secretary of State's office to request the necessary forms to dissolve your corporation.

In some cases, the state will have a Bureau of Incorporation or business division of the office you’ll reach out to specifically. Check out this list to find the division you need to contact for the state you’re incorporated in.

LLCs will similarly need to file a form notifying the state of dissolution. However, for some states it’s a different form. For example, in Pennsylvania, corporations file a Certificate of Dissolution while LLCs file a Certificate of Termination.

Step 4: Prepare and file final tax returns

You’re responsible for one last tax return upon dissolution.

On Form 1120 (C corporation tax return), Form 1120-S (S corporation tax return), and Form 1065 (tax return for LLCs taxed as a partnership), there’s a box that needs to be checked off indicating that it’s the final return. On Form 1120-S and Form 1065, you must also indicate it’s the final Schedule K-1.

There aren’t any other special considerations when completing the tax returns themselves. However, there are some additional forms you’ll need to file.

Form 966 must be filed in the case of dissolution or liquidation. This form must be completed and submitted within 30 days after the plan to dissolve is adopted.

Form 4797 must be filed if the sale or exchange of business property is part of the dissolution process.

Step 5: Prepare and file any information returns

Information returns are forms you submit to the IRS to supply exactly that: information. It’s not a tax return as it does not report any taxes owed.

The most common example of this is Form 1099-NEC which is used to report non-employee compensation. This is a required tax form if you hired contract workers and paid them more than $600 in the tax year.

Step 6: Pay any outstanding taxes owed

The two common taxes corporations need to settle when dissolving are corporate income taxes and employment taxes.

For corporate income taxes, you’ll calculate your final federal tax liability on the final tax return. This amount is paid to the IRS. 

In addition to federal corporate income taxes, most states levy a corporate income tax that will also need to be settled.

Employment taxes need to be filed using either Form 941 (Employer’s Quarterly Federal Tax Return) or Form 944 (Employer’s Annual Federal Tax Return). Form 944 is used when the annual liability is $1,000 or less. Ultimately, you should use the form you’ve already been using.

In addition to employment taxes, you must file Form 940 to calculate your last federal unemployment taxes bill.

Step 7: Close your IRS business account

To notify the IRS of your dissolved corporation and close your business account, you must send a letter.

The letter notifying the IRS should include the: 

  • Complete legal name of the business entity
  • EIN (employer identification number)
  • Business address
  • Reason you wish to close your account

Once this letter is drafted, you can send it to either of the following addresses:

Internal Revenue Service

MS 6055

Kansas City, MO 64108

Or

Internal Revenue Service

MS 6273

Ogden, UT 84201

Step 8: Close business accounts

Review your business’s accounts, licenses, and permits to ensure they’re closed.

You should review any:

  • Bank accounts
  • Credit cards
  • Lines of credit
  • Business licenses
  • Business permits

Close off any debts and be ready to distribute any assets to the shareholders or members of the corporation.

Step 9: File your records for safekeeping

Even with a dissolved corporation, the IRS and state offices can still request any reports or documents some years after the process has been completed.

It’s best to keep both physical and digital copies using a cloud storage solution.

At a minimum, the IRS can request select forms up to three years after the dissolution. But for other forms, the IRS can request them on an indefinite basis.

Liquidating assets

The process of liquidating assets is to turn any tangible or intangible assets into cash that can be distributed to owners.

Examples of tangible assets include equipment, office furniture, real estates, and vehicles. Examples of intangible assets include intellectual property like copyrights, patents and trademarks.

These assets are sold at either a gain or loss. Whether it’s a gain or loss isn’t determined by the original purchase price, but rather the tax basis of the asset. What this means is the value of the asset after considering amortization or depreciation. If you bought a vehicle for $20,000 and claimed $2,000 in depreciation expenses over the year, the tax basis bones $18,000.

As part of the liquidation process, you’re responsible to file Form 966 with the IRS.

How to liquidate your assets

When liquidating assets, start by creating a list of all the assets that will be liquidated and use it to document the amount obtained for each. 

No matter the asset, clearly document the exchange and value paid.

Auction or exchange website that specializes in your industry are the best way to find the right buyers. Otherwise, general sites like eBay or Craigslist get the job done.

For intangible assets, your best customers are competitors who might be interested in any outstanding projects, intellectual property, or customer lists.

While private sales will net you the most value, business brokers or professional liquidators help take some of the stress out of the process.

Selling assets to any of the business owners, members, or shareholders can be tricky, and possibly unallowed. Start by reviewing the articles of incorporation (or articles of organization) and bylaws or operating agreement to ensure nothing is preventing the sale. It’s best to check in with a lawyer or accountant to ensure no rules are being broken.

Another option for assets that might be difficult to sell is charitable donation. This results in tax deductions that will minimize the last tax bill.

Don’t forget about unpaid invoices. If you have any outstanding accounts receivable, look into invoice factoring. Factors pay you for unpaid invoices upfront and then handle the collections process on your behalf.

Special considerations for S corporations

An S corporation isn’t a separate legal entity type, but rather a tax designation. It’s created by starting a C corporation or LLC and then applying for S corporation status.

The main consideration is the distribution of assets which must be reported on the final tax return, Form 1120-S, and Schedule K-1. Shareholders use the information on Schedule K-1 to complete their personal tax returns.

Otherwise, the process depends on whether you initially formed as a C corporation or LLC. When in doubt, reach out to a lawyer or accountant to help navigate the situation.

How dissolving a corporation affects your taxes

How dissolving a corporation affects your taxes depends on whether the corporation is a pass-through entity.

S corporations and LLCs taxed as partnerships are pass-through entities. What this means is that the business isn’t responsible for the tax liability, rather it “passes through” to the business owners. They report and pay their tax liability on their personal tax returns.

C corporations and LLCs taxed as corporations are not pass-through entities. They have their own tax liability.

How the dissolving process affects your taxes depends on what your corporation falls under.

Pass-through entities

Businesses that operate as pass-through entities are required to provide each owner a Schedule K-1.

Schedule K-1 reports each owner’s portion of the business’s taxable income. In the case of dissolving the corporation, this includes any gains or losses that come from selling business assets.

You’ll likely be able to claim the overall net loss against any other income you had in the year.

Depending on the assets you hold and their market value, dissolving your pass-through entity and liquidating assets could lower your tax bill.

Non pass-through entities

If your business isn’t a pass-through entity, the corporation reports the gain or loss from the liquidation process. While it affects the corporation’s tax bill, it doesn’t immediately pass on to the owners.

Instead, shareholders “sell back” any shares or stocks that they have in the company. The value they get is determined by the percentage of the company owned and the assets left to distribute after all debts are paid.

If someone owns 10% of a company and it has $100,000 in assets, they get $10,000 in distributions. If this is less than their initial investment, they can claim a capital loss on their tax return.

For amounts that are larger than the initial investment, they are treated as a short- or long-term capital gain. They are short-term gains if the investment was for one year or less, while anything longer is treated as a long-term gain.

Short-term gains are treated as regular taxable income. They are taxed based on your tax bracket.

Long-term gains have their own tax rates that depend on your taxable income and how long you held the asset.

The importance of recordkeeping

The IRS can still request documents and records from a corporation years or even indefinitely beyond the dissolution.

To start, be sure your bookkeeping is caught up (Bench can help) and your accounting is up-to-date. 

As you’re collecting all the necessary documents for a final tax filing, take this opportunity to organize the documents from the entire lifetime of the corporation so they’re readily available if needed.

Store these documents in a safe place and ensure everyone who may need access has it.

While dissolving a corporation is a long process, you only need to do it once. Take the time to do it right and be detailed in your documentation. As always, when in doubt talk to a lawyer or accountant to have peace of mind that you’re complying with the rules.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.
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