Any individual involved in a business may have come across the notion of dissolving before. It is crucial to understand:
- What a dissolution is,
- When an entity can be dissolved,
- How to dissolve a business, and
- Whether a dissolution is the right option for you.
Our business attorneys here at Newburn Law, PC have years of experience helping our clients understand each of these elements of a dissolution. If you have any questions, it is imperative that you speak with an experienced lawyer to understand your options and whether a dissolution is right for you.
What is a dissolution?
A dissolution is a process of legally ending your business to cease the continuation of the company that the government taxes. This process includes filing appropriate legal paperwork with the government (Secretary of State and IRS) and settling all outstanding business debts.
A dissolution can be voluntary or involuntary. A voluntary dissolution is a deliberate decision made by the business owner(s) to end business operations for reasons stated in the proceeding section. For LLCs (non-corporations) with multiple partners, the decision to dissolve a business can involve “informal” discussions where partners agree that dissolution is the best route for the company. However, for corporations, the Board of Directors typically must draft a dissolution proposal, and a shareholders’ meeting is held to vote on dissolution.
An involuntary dissolution occurs when a dispute within the business interferes with its operation. In this case, the shareholders file a lawsuit requesting a dissolution, and the court approves the lawsuit and issues a dissolution order.
Why would an LLC dissolve?
Businesses may decide to dissolve for several reasons, including:
- The business running its course,
- Mismanagement/poor leadership,
- Internal disputes and disagreements between key partners,
- Relocating a business to another state or country,
- Merging the business with another company (though some states allow transfer/conversion of LLCs to corporations without a formal dissolution process), or
- Poor accounting and/or cash flow problems.
Poor accounting and cash flow problems often lead to insolvency, which occurs when a business cannot pay its debts. This may inevitably lead to the company having to liquidate (often under the supervision of an insolvency consultant, who may sell off business inventory/assets at substantially lower prices to generate cash flow to pay debts) and finally dissolve.
When can an LLC dissolve?
A business can dissolve at any time during the year. However, there are deadlines for filing specific forms (which vary by state) once the dissolution process has begun. The following must be noted for a business to be eligible for dissolution:
- In some states, a business can only apply for dissolution when debt-free. In contrast, other states allow businesses to file for dissolution before even notifying creditors or attempting to resolve any claims.
- Typically, the business cannot have sold or traded any assets within the last three months.
- The business typically cannot have changed its name within the last three months.
What documents need to be in place to allow a dissolution?
First, the company owners must file the Articles of Dissolution to dissolve a business, which is a notice to the state or relevant authorities, city, or county to discontinue taxing your business because it no longer exists. Each state has its own instructions and Articles to file. Colorado’s can be found here.
When filing Articles of Dissolution, your business must have already shut down operations or been sold, and the company must have paid all of its employees. Articles of dissolution must include the conditions of the dissolution, any sale of assets, division of duties among managers/shareholders, and compensation of shareholders.
- Form 966 – Corporate Dissolution or Liquidation must be filed with the IRS, notifying the IRS to identify your business status as being dissolved. The form must be accompanied by documentation proving that the shareholders have consented to the dissolution.
- Final Income/Employment Tax returns must also be filed and marked “final” to notify the IRS that they will be the last tax returns your business will be filing.
How to dissolve an LLC
The steps you must follow include:
- File a final income/employment tax return with the IRS. The exact type of tax return you file depends on the classification of your business, among these categories:
- Sole proprietor: someone that owns an unincorporated business on their own.
- File Form 1040 Self-Employment Tax if your net earnings are $400 or more [or]
- File Form 1040-SR Profit or Loss From Business with your individual tax return for the year in which you are dissolving the business
- Partnership: a business owned and operated among multiple business partners
- File income taxes and report capital gains and losses via Form 1065 – U.S. Return of Partnership income for the year in which you are dissolving the business.
- Corporation: a legal entity created by individuals or shareholders separate from its owners and operates as a for-profit business
- File income taxes and report capital gains and losses via Form 1120 or 1120-S for the year in which you are dissolving the business.
- If you plan to liquidate any assets, you must file Form 966-Corporate Dissolution or Liquidation.
Regardless of the classification of your business (sole proprietor, partnership, corporation), the following must be filed:
- If you are selling your business, file Form 8594 – Asset Acquisition Statement
- If you have sold or exchanged property, you must file Form 4797 – Sales of Business property for each year.
- Compensate Employees: All employees’ final wages and compensation must be paid, and final federal tax deposits must be made and reported to the IRS via form 941 – Employer’s Quarterly Federal Tax Return or Form 944-Employer’s Annual Federal Tax Return. You must also provide all employees with their final W2s and terminate retirement plans and other health benefit programs.
- Pay all taxes that your business owes.
- If applicable, report all payments to contract workers paid at least $600, using form 1099- Nonemployee Compensation.
- Cancel your Employer Identification Number (EIN), which is the federal taxpayer identification number assigned to your business. This process includes sending the IRS a letter including your business EIN, business legal name and address, and why you’d like to close the account. Your EIN cannot be canceled until you have paid all outstanding taxes.
- Keep a copy of all your records, including employment tax records (for at least four years) and any property records (until the period of limitations expires for the year you discarded that property).
You can find more details on the IRS website about each of these steps here: https://www.irs.gov/businesses/small-businesses-self-employed/closing-a-business.
Who needs to be notified?
When you dissolve a business, you must notify multiple entities and individuals regarding your plan to dissolve. Below is a list of the specific entities and individuals that you must notify:
- IRS must be notified via filing your Articles of Dissolution.
- State or county authorities must be notified via the Articles of Dissolution.
- Creditors/debtors must be informed of the dissolution to make appropriate arrangements to be repaid. When notifying creditors/debtors, the deadline for submitting their claims must be stated, and it can be stipulated that any claims submitted past the deadline will not be accepted.
- Employees must be notified and fully compensated before the dissolution.
Pros and Cons of Dissolution
Like any major business decision, there are pros and cons to dissolving a business.
Some of the pros include:
- It can be a psychological and financial relief from a struggling business.
- If done properly, the process can be quick; it can take as little as three months to dissolve officially.
- The filing fee, if applicable, is not too hefty (typically a maximum of $100 depending on the state).
- Putting an end to filing annual reports and paying fees and taxes.
- If there is misconduct within the business, no investigation will be typically undertaken if the company dissolves.
Some of the cons include:
- Creditors can object to the dissolution, and those creditors can potentially take legal action. This legal action may force the business to pay outstanding debts.
- The leases on any properties owned by the business are not automatically terminated when the business is dissolved. A Creditors Voluntary Liquidation (CVL) application must be filed.
- Errors may occur when distributing assets during a dissolution, which may result in legal action being taken against the business.
Whether or not dissolving your business is the right decision for you will completely depend on the facts of your situation. Consulting with experienced business lawyers can help make that decision clearer, as lawyers can answer any questions you might have and guide you based on the facts of your situation.
Liquidation vs. Dissolution
Major questions many business owners ask are:
- What is the difference between liquidation and dissolution?
- Are they the same?
- Should I liquidate my company or dissolve it?
- What are the consequences of each type of business event?
Liquidation is one of the steps in the process of closing a business, not to be used interchangeably with dissolution, which is the complete and official cessation of a business. Liquidation involves selling assets to acquire emergency capital/cash flow to pay off debts.
A company that has been liquidated and has paid off outstanding debts does not necessarily have to be dissolved and can remain a legal business entity, even if it ceases business activities. However, a business that has been dissolved is no longer a legal business entity.
How An attorney can help you
The dissolution of a business involves multiple entities and can be complicated; a corporate lawyer can help simplify and facilitate the entire process, especially if you are a large business. A lawyer can break down the process and discuss your dissolution options and help you prepare and file the necessary legal documents.
As several entities are involved in the dissolution process, a lawyer will ensure that none are overlooked, including federal, state, and local authorities, shareholders, employees, debtors, and creditors.
Contact our lawyers here at Newburn Law, PC today for a free consultation so that we can help you make the best decision for your company.
