How to Close an S Corp Properly Step-by-Step

Key Takeaways

• Closing an S Corp involves shareholder approval, asset liquidation, and final filings with state and federal agencies.
• Notifying creditors, employees, and tax authorities is essential to prevent legal complications.
• Final federal and state tax forms, including IRS Form 966 and final employment tax returns, must be filed.
• Licenses, permits, and business accounts should be properly canceled to avoid ongoing obligations.
• Following proper dissolution procedures ensures the S Corp is legally closed and helps avoid future penalties.

Knowing how to close an S Corp correctly will ensure you dissolve your business legally. You'll have to do the following: 

1. Obtain a shareholder vote to dissolve.
2. Stop conducting business.
3. Notify creditors.
4. Liquidate assets.
5. File a certificate of termination.
6. File final government documents.

How to Dissolve an S Corporation

Check your state's business codes to make sure you comply with the necessary procedures to legally end the business.

Typically, your shareholders will have to vote to dissolve the S-Corp. The decision to dissolve the business has to be a majority vote. Some states only require a simple majority, while others call for a supermajority or something else, like a two-thirds majority. If your corporation's bylaws specify a higher maximum, you'll have to follow the bylaws.

Stop doing business on behalf of the S-Corp. Instead, managers should focus on procedures to legally dissolve the business and liquidate assets. You can still engage in any transactions and communication related to closing the business.

The S-Corp isn't exempt from any legal proceedings that were in place before the dissolution process. You'll have to notify all creditors with pending claims against the S-Corp that you are closing your business. Do this in writing.

Notify All Relevant Parties

When determining how to close an S Corp, it’s crucial to notify all relevant parties to ensure legal compliance and minimize future liability. Key parties to notify include:

• Creditors: Send written notification to creditors about the dissolution and provide instructions for submitting claims.
• Vendors and Suppliers: Notify any service providers or vendors about the closure and settle outstanding accounts.
• Customers: If applicable, inform clients about the business closure to maintain goodwill and close out any remaining obligations.
• Employees: In compliance with the Worker Adjustment and Retraining Notification (WARN) Act (if applicable), provide sufficient advance notice (typically 60 days) to employees regarding layoffs.
• State Agencies: Notify your Secretary of State and any state taxation departments. Some states require additional notice to franchise tax boards or revenue departments.

Proper communication helps protect your business and its leadership from future claims or disputes.

Liquidation and Final Actions

Liquidation involves the distribution and sale of business assets and property. Proceeds of distribution and sale go toward paying off any outstanding obligations and debts. In many states, creditors have first rights to claim sale proceeds in order to settle debts. Others eligible to receive proceeds include company members and owners.

After creditors are paid, any remaining assets should be distributed among shareholders. Refer to the corporate bylaws to see how much each shareholder receives, based on ownership percentage. If your bylaws don't specify this, distribute according to the default rules in your state.

In most cases, a business with at least 100 employees must give them sufficient notice that it's dissolving; the typical time frame is a minimum 60 calendar days advance notice, no matter what type of business you run.

Issue final W-2s to company employees, as well as 1099 forms to any independent contractors.

Issue final K-1 statements to shareholders, and be sure to check "Final K-1" on the form. Send copies of all these forms to the IRS, along with the S-Corp's final income tax return.

Submit a certificate of termination to the appropriate state agency. You must make sure to settle outstanding tax and state income obligations, along with any unpaid taxes. Getting clearance from your state's finance departments is often required to legally dissolve your business.

Take care of final tax documents by filing the appropriate paperwork with the IRS. This includes Form 966, and you must file it within 30 days of dissolution and liquidation. You must include the following on Form 966:

• S-Corp name
• S-Corp address
• Incorporation date

If you conducted business in other states as a foreign corporation, you'll have to file dissolution paperwork in those jurisdictions, too.

Depending on local and state law, you may be required to cancel any permits or licenses the S-Corp held. You must also do the following (this applies to all types of businesses): 

• Cancel any registrations you had with local government.
• Close business bank accounts.
• Cancel business credit cards.
• Close your Employer ID account with the IRS.

Check the "Final Return" box at the top of all returns so that the IRS is aware that you're dissolving your business. Any business property that's disposed of when you dissolve your S-Corp must be reported to the IRS using Form 4797. You'll attach this form to the business's final tax return.

Finally, notify the IRS in writing with contact information for the person who's responsible for payroll records for the company. Include that person's name, address, and telephone number. The IRS may contact this individual once the business is dissolved if any issues come up related to deposits, returns, or employment taxes.

While it may seem easiest to simply stop conducting business, that's not the legal way to terminate an S-Corp. You'll have to follow several steps to end the business properly, so make sure you adhere to all state regulations and guidelines to avoid any future legal hassles.

Maintain Records After Dissolution

Even after successfully closing your S Corp, it’s important to retain business records for legal and tax purposes. Recommended retention periods include:

• Tax records: At least seven years.
• Employment records: Four years after termination of employment.
• Corporate documents (meeting minutes, dissolution paperwork): At least seven years.
• Financial records (bank statements, canceled checks, ledgers): Seven years.

Proper record retention helps if the IRS or state authorities audit your business after closure.

Close Business Financial Accounts

Closing your business financial accounts is a vital step in completing the process of how to close an S Corp. Steps to consider:

• Close all business bank accounts after settling any final debts or obligations.
• Cancel business credit cards and lines of credit.
• Notify payment processors and merchant services providers.
• Keep records of the closed accounts for several years, as required by IRS record-keeping rules.

These steps ensure that the company is no longer able to conduct business transactions, protecting against unauthorized use of funds.

Cancel Permits, Licenses, and Registrations

To fully terminate business operations and avoid future obligations, cancel all active permits, licenses, and business registrations associated with your S Corp. These may include:

• Local business licenses
• Sales tax permits
• Health department permits (for food-related businesses)
• Professional licenses
• State and local business registrations
• Out-of-state registrations if you operated as a foreign entity

Failure to properly cancel these may result in ongoing fees or penalties.

File Required Final Tax Documents and Returns

As part of the process of how to close an S Corp, submitting the correct federal and state tax forms is essential to finalize dissolution. Important IRS forms may include:

• IRS Form 966 (Corporate Dissolution or Liquidation): Must be filed within 30 days after adopting the resolution to dissolve the corporation.
• Final Employment Tax Returns: File Form 940 (Federal Unemployment Tax) and Form 941 (Employer’s Quarterly Federal Tax Return), marking them as “Final.”
• Final S Corporation Tax Return: File Form 1120-S, checking the box indicating that it is a final return. Include Schedule K-1s for shareholders, also marked as final.
• Form 4797: Report the sale of business property if applicable.
• State Tax Filings: Submit final state tax returns where your S Corp operated, including sales tax returns if applicable.

Ensure you also close your EIN account with the IRS by sending a letter that includes the business name, EIN, and the reason for closure.

Frequently Asked Questions

1. What is the first step in closing an S Corp?
   The first step is obtaining shareholder approval through a formal vote in accordance with the corporate bylaws or state law requirements.
2. Do I need to notify the IRS when closing my S Corp?
   Yes, you must file IRS Form 966 along with your final tax returns and mark all returns as "Final." You should also inform the IRS in writing to close your EIN account.
3. How do I handle outstanding business debts when closing an S Corp?
   Debts must be paid before distributing any remaining assets to shareholders. Notify creditors in writing and settle outstanding claims during the liquidation process.
4. Are there penalties for not properly dissolving an S Corp?
   Yes, failure to officially dissolve may result in continued tax obligations, penalties, and state-imposed fees.
5. How long should I keep business records after closing an S Corp?
   Maintain tax and financial records for at least seven years, and employment-related records for at least four years after closing the business.

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