Wrapping up a business requires more than just putting a closed sign on the window. In order to avoid complications, you need to file appropriate final tax returns for the business to let state and federal authorities know that you've decided not to continue the business any longer. You'll usually find a box to check on your business tax return to indicate that it's a final return, but you'll also be able to show that your business has wrapped up successfully by preparing a balance sheet that has zero balances for all the accounts of the business. Let's take a look at the typical process of liquidating a business to see how you can zero out your balance sheet by the time you're done.
Offsetting assets and liabilities
When the owners of a business choose to stop operating the business, they're typically left with assets and liabilities. If the amount of assets exceeds the value of the liabilities, then wrapping up the business is relatively simple. Usually, you can take the assets and either use them directly to pay creditors and eliminate the liabilities of the business or sell them to raise cash to repay those liabilities. The business can distribute any cash or assets that are left over to the owners on a pro-rata basis in proportion to their equity interest in the business.
If liabilities exceed assets, then the situation gets more complicated. Sometimes, creditors won't have recourse to the individual owners of the business, and in that case, the business debt will be forgiven. That can result in an item of income for the business because of the cancellation of indebtedness, and once that happens, the value of the liability on the balance sheet becomes zero. Alternatively, if the business owners assume the debt, then the liability for the business itself becomes zero as well.
Technical dissolutions of continuing partnerships
If your business is set up as a partnership, then whenever there is a change in who the partners are, there's technically a dissolution of the old partnership and a creation of a new partnership that includes the new partners. That raises the question of whether you have to zero out the balance sheet of the old partnership.
Tax regulations aren't clear, and there's disagreement on how best to account for this. Some zero out the balances as they would with any dissolution. Others prefer to keep the old account balances immediately prior to dissolution and transfer those numbers to the new partnership directly. In the absence of more definitive guidance from tax authorities, it's probably safest to go ahead and zero out balance sheets regardless.
Closing out a business can be a stressful situation, but it's crucial to inform tax authorities that your business is wrapping up and that they should therefore expect no further returns in the future. Checking the final-return box is a smart move, but zeroing out your account balances on your balance sheet provides further notice that you've ended your business.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at [email protected]. Thanks -- and Fool on!
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.