How to Dissolve and Liquidate an S Corporation

Liquidating an S corporation requires some specific steps to be done legally. An S corporation falls under the state laws that dictate other types of corporations, but what sets it apart is pass-through taxation, which is approved by the IRS. Since an S corporation is dictated by state laws, any steps taken to liquidate and dissolve the business must follow the laws of the company's state of operation. The codes around state business registration and operation outline the required procedures that corporation owners must take in order to legally terminate an S corporation and liquidate its assets.

There are six major steps required to dissolve an S corporation:

  1. Take a vote and make a majority decision among the shareholders to dissolve the S corporation. From there, the managing partners may be able to begin following the state dissolution process, but they must have authorization from the S corporation's shareholders.
  2. The next step is to cease all business operations that relate to the S corporation. The managers must focus solely on liquidating assets and dissolving the business within a reasonable amount of time. However, those involved in the dissolution process can engage in transactions and communications that are necessary to liquidate the assets of the business. One example is a law in the state of Texas, which allows an S corporation to continue engaging in or file for civil, criminal, or administrative legal proceedings, as long as the action relates to something that was outstanding prior to beginning the process of dissolution. Dissolving the S corporation will not allow the business to withdraw or be exempt from any legal proceedings that began before the process started.
  3. It's also important to notify all creditors of the plan to dissolve the S corporation. Laws in each state require that the managers of the business inform any creditors who have pending claims with the S corporation. By taking this step, it's easier to identify who has the right to claim a portion of the proceeds after the company assets have been liquidated.
  4. After notifying creditors, the next step is liquidating all assets of the business. Liquidation refers to selling and distributing any property and assets owned by the business. After selling and distributing the property, the proceeds will go toward paying any obligations and debts held by the S corporation. Members, owners, and creditors could be on the list of those who will qualify to receive any of the proceeds from the liquidation process. In certain states, the creditors will be first to claim any proceeds to settle outstanding debts. From there, the owners could receive any remaining proceeds, as long as the debts and obligations have been resolved.
  5. Upon completion of the dissolution process, the company owners will need to file the required certificate with the applicable state agency in which the S corporation operates and is registered. Since an S corporation is a tax-paying entity, it must also settle any outstanding tax obligations for the previous year, along with any unpaid taxes from prior years. Before an S corporation can be legally dissolved, it will typically need to clear anything outstanding with the state finance department.
  6. The sixth and final step of dissolving an S corporation is filing the last IRS tax documents. The corporation must file IRS Form 966 within 30 days of making the decision to liquidate and dissolve the business. This form requires certain information, such as:

Additionally, the corporation must file Form 1120S within 90 days of the date of dissolution. The final return must be filed with the IRS by the 15th day of the third month following the completion of the dissolution process.

Tax Consequences of Distributions From S Corporations

All credits, deductions, losses, and income of an S corporation are passed through the business to the shareholders. They must then report these amounts on their personal tax returns. Since the profits of an S corporation are taxed to the shareholders, a safeguard is necessary to protect shareholders from being double-taxed during the distribution of the money. State laws and tax rules help to track and adjust the amounts, based on the stock held by the shareholder.

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