Dissolving a Company

Dissolving a company refers to winding up the business formally. In addition to ceasing business operations, the dissolution process involves various other formalities. Usually, you need to file articles of dissolution or a similar document with the secretary of state. Dissolution terminates the existence of a company, but you must still:

  • Wind up the operations
  • Liquidate the assets
  • Take other steps to end its existence

The impact of dissolution on the shareholders of the company depends upon its financial position. The shareholders may:

  • Get their original investment back
  • Receive nothing
  • Have to pay money if the company becomes insolvent

The first step to begin the process of dissolution is to hold a board meeting and pass a resolution to dissolve the company. Once the shareholders approve the board decisions, you can file articles of dissolution. You must file this document in the same state where your company was incorporated. You may also have to file some other forms, depending upon your state's requirements.

Types of Dissolution

Dissolution can either be voluntary or involuntary.

Voluntary Dissolution:

A voluntary dissolution usually involves the following essential steps:

  • Filing articles of dissolution or a similar document with the state.
  • Ceasing business operations.
  • Liquidating the remaining assets of the company.
  • Repaying all outstanding debts, claims, and taxes.
  • Distributing any surplus funds among the shareholders.

Involuntary Dissolution:

When any of the company shareholders files a lawsuit requesting its dissolution, the court may issue an order to dissolve the company. This usually happens when the relationship between the shareholders is such that it prevents the company's operation.

In some states like Arizona, a company is dissolved by a state agency if it fails to meet the state filing requirements. Such dissolution is usually known as administrative dissolution. It often means the company ceases to exist without the knowledge of its shareholders. It may result in substantial adverse consequences. For example, the shareholders may become personally liable for liabilities incurred because of continued operations after the dissolution.

Liquidation of Assets

After a company is dissolved, it must liquidate its assets. Liquidation refers to the process of sale or auction of the company's noncash assets. Note that only those assets your company owns can be liquidated. Thus, you can't liquidate assets that are used as collateral for loans. Assets used as security for loans must be given to the bank or creditor that extended the loan, or you must pay off the loan before selling such assets.

Shareholder Distribution

The final step of dissolution involves distributing the company's remaining assets among the owners (a.k.a. shareholders). The assets may include the money kept in bank accounts or obtained from disposing of the company's noncash assets. The payment to company shareholders is done on a pro-rata basis, i.e., in the ratio of their ownership percentages.

If a company is doing well, it may have leftover cash and assets after repaying its taxes and liabilities. In such cases, the leftover amount is totaled and divided between shareholders on the basis of their ownership stake. In exchange for getting back their investment (in full or part), the shareholders return their shares to the company, which are then canceled.

If a company returns any money to its shareholders while still having a debt outstanding, the creditor can sue, and the shareholders may have to return the received amounts. If there are any unpaid taxes, shareholders can be held personally liable to repay those taxes.

If the amount distributed to any shareholder is $600 or more, you must also issue Form 1099-DIV. This IRS form reports the amount of investment the company returned. The distribution amount the shareholder receives is not taxable if it does not exceed the original investment.

If any shareholder receives a distribution amount of less than his or her original investment, he or she can claim a capital loss in his or her annual tax return. If the distribution amount received is more than his or her original investment, the excess amount will be treated as short- or long-term capital gain, depending upon the period of investment. Investment held for a period of one year or less will be subject to short-term capital gains tax, whereas that held for more than a year will be subject to long-term capital gains tax.

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