No matter how good or bad the situation in the economy is, many companies simply can’t stay in business and they are forced to either permanently dissolve their operations or reorganize into another entity. Without proper tax planning, both dissolution and reorganization could come with some unexpected and undesirable tax implications.
It’s important to integrate financial planning into the possibility of closing a business. It may not be something you want to think about when things are just getting started, but it is a step that can be very beneficial just in case that unthinkable happens. You need to understand how different tax laws impact different business structures because that might influence your decision on how you incorporate in the first place.
Gain, Loss, and Depreciation
If you’re business is being dissolved, that theoretically means you’re not actually making any money – so what is there left for the government to tax? While there are laws and regulations surrounding a number of taxable activities, it mostly happens during liquidation, when assets are sold off. This is taken as a sign of gains or losses or attempting to recapture depreciation. In other words, this tells the federal government that something has happened that requires some attention.
For a sole proprietorship or partnership, this basically means that any long-term capital gains will be taxed at 15%, while any short term gains will be taxed at the regular rate. A C corporation, on the other hand, will face different problems. In this case the company will first get taxed at corporate rates, and then after the proceeds are distributed to the owners it is taxed again.
An LLC has a couple options during dissolution because while they can opt for corporate tax status they still have the choice to go with a different structure to avoid this kind of double taxation. There are still a number of complex laws surrounding LLCs, though, just to make sure companies aren’t using them as a tax dodge. In the end, it’s all about knowing how your business can be taxed on any gains or losses made during the liquidation process.
Avoid Problems from the Start
During the initial, exciting startup phase of any new business, we never want to think about the possibility that it might not succeed. Unfortunately, even the best companies can find themselves in circumstances that lead to dissolution. Planning ahead from the very beginning can help avoid many of the tax consequences of dissolving a business.
One of the most effective things you can do is include a plan for this eventuality in the company’s Articles of Organization and operating agreement. This is where you can set out the rules and details for transferring interests, dealing with members leaving the company, or even completely dissolution. It may not be something you want to think about during the early stages of the business, but compared to the possibility of increased tax rates or even double taxation, you can’t afford to overlook this step.