You can dissolve a corporation in two ways, in most states.
The Wrong Way to Stop, Cancel or Dissolve a Corporation
The wrong way to dissolve a corporation is simply to stop filing your annual report with the state, stop paying the state its annual corporation fee (if the state levies such a fee), or to ignore some other state requirement. In other words—and this is a bit graphic, sorry—break enough rules, and the state will in effect “execute” your corporation.
The Right Way to Stop, Cancel or Dissolve a Corporation
The right way to dissolve a corporation works differently. When you dissolve a corporation or stop a corporation or cancel a corporation the right way—usually because you no longer need the corporation for a business or investment—you take the following steps:
1. Liquidate assets and pay off debts.
In general, you’ll want to liquidate (or selloff) the assets of the corporation and use any proceeds to pay down and payoff the debts of the corporation. By the way, you want to do as much of this liquidation within the corporation as you can so the gains and losses related to the liquidation are clear-cut.
2. Distribute any remaining assets to shareholders.
Any assets you have left over should be distributed to shareholders. Note that gains and losses will be triggered by the distributions of assets. Assets which have been carried on the corporate books at a value less than their fair market value trigger a gain when distributed to shareholders. The gain equals the difference between the asset’s fair market value and its book, or carrying, value. Assets which have been carried on the corporate books at a value greater than their fair market value trigger a loss when distributed to shareholders. The loss equals the difference between the asset’s book, or carrying, value and its fair market value. When you complete step 2, the corporation should have no assets and no liabilities.
Note: If you still need to pay expenses for attorney and accountant fees—erhaps related to stopping the corporation—you should pay these by this point, too.
3. File articles of dissolution.
The state where you formed your corporation will require you to file articles of dissolution. The articles of dissolution, which will resemble the original articles of incorporation, usually require the corporation to indicate that the board of directors has approved the dissolution. The dissolution process may also require additional steps. Some states, for example, require a dissolving corporation to get an “all clear” report or certificate from the state tax authority. Note that many states provide an articles of dissolution form at their secretary of state web site.
4. File a final tax return.
After the corporation dissolves, the final corporation tax return needs to be filed. The final federal corporation tax return needs to be marked as the “final” return and should include a 966 form. Note, too, that the tax return should show all of the corporation’s assets as either being sold off (see step #1 above) or distributed to shareholders (see step #2 above).
Three Tips for Dissolving a Corporation
I have three tips related to the preceding discussion of how to dissolve a corporation.
1. Here’s the first tip: You want to think about the dissolution date in relation to any last-minute corporation business deductions you want to claim. As a practical matter, any deductions you want to put on the corporation’s final tax return need to be paid by this date in order to get into the last tax accounting year and onto the final tax return. Accordingly, don’t dissolve too fast and don’t dissolve before you pay all (or at least most of) your bills. (Sometimes people pay me, the tax accountant, early for the final tax return for just this reason.)
2. A second tip relates to the dissolution date and the final tax return’s due date. The dissolution date is actually the date that the corporation’s life ends and so starts the 75-day counter for the due date for corporation’s last tax return. What you want to do, then, is delay the dissolution long enough so that you have plenty of time to do the corporation tax return.
3. A third and final tip is this. If you can possibly do it, dissolve a corporation before the calendar year ends. If you dissolve a corporation on 12/31/2011, for example, the corporation’s final tax return is for the full calendar year 2011 and is due on March 15, 2012. If you let the dissolution date slide a month into the future, or January 31, 2012 in this example, you still owe the 2011 tax return… but now you owe another tax return for the short, final one-month year that ends on January 31,2012. This tax return, which is actually the final return, is due on April 15.
Final Caution: Inadvertent Dissolutions of a Corporation
I want to make a final comment before ending this short article.
If you inadvertently cause your corporation to dissolve, that dissolution typically triggers some horrific tax accounting problems. In essence, the dissolution means that the assets and liabilities have been distributed to shareholders and any “unrealized” gains and losses on those items (because the items’ fair market values differ from the items’ book values) get recognized.