Federal and State Tax Concerns to Address When Closing a Business

 Posted on June 16, 2024 in Small Business Taxes

While owning and operating a small business can be very rewarding, there are some situations where businesses may fail. In these situations, business owners or partners will need to understand how to wrap up and dissolve the business. This process will involve a variety of steps, including procedures that must be followed to meet all applicable federal and state tax obligations. Properly managing these tax concerns can help ensure a smooth closure and prevent future legal issues. An experienced attorney can help business owners navigate these complexities and avoid potential issues that could lead to penalties.

Addressing Federal Tax Issues with the IRS

When closing a business, it is crucial to notify the IRS and resolve any outstanding federal tax obligations. This process will include the following steps:

1. File final tax returns: Depending on how the business was structured, the appropriate tax returns must be filed for the year the business was closed. For a sole proprietorship, Schedule C (Form 1040 or 1040-SR) must be filed with the owner’s individual tax return. For a partnership, Form 1065 must be filed, and the "final return" box can be checked to indicate that the business has closed. For a corporation, Form 966 must be filed to dissolve the corporation, and Form 1120 or 1120-S will be filed as the final tax return. LLCs may be classified as either partnerships or corporations, and the applicable forms will need to be filed. Other forms may also be required, including Form 4797 to report sales of business property and Form 8594 to report asset acquisitions if a business is sold.

2. Pay employee wages and employment taxes: Final wages and other forms of compensation must be paid to any employees. Employment taxes will need to be withheld and paid, and these taxes may be reported to the IRS using Form 941 or 940. Employees must be provided with W-2 forms for the final year in which wages were paid. An employer may also need to take steps to terminate retirement plans for employees.

3. Pay outstanding taxes: All outstanding federal taxes must be paid. These may include income tax, payroll tax, and any other applicable federal taxes. Failure to settle these obligations can result in penalties and interest.

4. Cancel the EIN: After filing the final tax returns, a business owner will need to cancel their Employer Identification Number (EIN) by sending a letter to the IRS. This letter should include the complete legal name of the business, the EIN, the business address, and the reason for the cancellation. 

Filing Requirements With California State Agencies

In addition to federal tax concerns, state tax obligations must be addressed when closing a business in California. Here are the steps to follow:

1. File dissolution forms: Depending on how the business was structured, different forms will need to be submitted to the California Secretary of State. Corporations will need to file Form DISS STK (Certificate of Dissolution) and/or Form ELEK STK (Certificate of Election to Wind Up and Dissolve). General partnerships will need to file Form GP-4 (Certificate of Dissolution), while limited liability partnerships will need to file Form LLP-4 (Limited Liability Partnership Notice of Change of Status). LLCs must file Form LLC-4/7 (Certificate of Cancellation) and/or Form LLC-3 (Certificate of Dissolution).

2. File tax returns with the Franchise Tax Board: Any delinquent state tax returns must be filed, and taxes or penalties that are owed must be paid. A final tax return for the year in which the business closed must be filed. Writing “final” at the top of the first page of the tax return will notify the FTB that the business has closed.

Additional State Tax Issues

When closing a business, there are a few other concerns related to state taxes that may need to be addressed, including:

• Sales tax license: If the business held a sales tax license, that license should be

• canceled or closed after the final sales tax report is filed.

• Property taxes: The county assessor's office must be notified, and outstanding property taxes may need to be paid.

• Business licenses: State or local business licenses and permits must be canceled.

• Unemployment taxes: A final unemployment tax return must be filed with the Employment Development Department (EDD) and any remaining obligations must be settled.

• Notifications: Interested parties, including creditors, vendors, and clients, must be notified of the closure of the business.

• Financial accounts: Business bank accounts or credit cards must be closed.

Contact Our Santa Clara County Small Business Tax Attorney

Addressing the tax issues related to the closure of a business can be a complex matter. At John D. Teter Law Offices, our San Jose business tax lawyer can help ensure that all legal requirements for a business’s taxes are met, and we can work to resolve any outstanding tax issues with the IRS or California state agencies. Contact us at 408-866-1810 to schedule a consultation and get the legal help you need when closing a business.