Why Dissolve Your Startup Before Year-End? Tax & Legal Deadlines

As the year ends, you might be thinking about closing your startup business and starting fresh. If so, it's crucial to understand why shutting down before January 1st is so important. The clock is ticking, and missing this deadline could mean getting hit with unexpected taxes, penalties, and legal headaches that can weigh you down in the new year.

However, it's essential to be aware of certain deadlines and best practices to ensure your company avoids unnecessary fines, taxes, and penalties that may arise if dissolution extends into the next calendar year. We will also cover some specifics for Delaware corporations and limited liability companies, while also providing general rules applicable to other states.

Key Takeaways

• Complete corporate dissolution paperwork by December 31st to avoid unexpected taxes and fees.

• Settle all outstanding debts, close business accounts, and distribute remaining assets before year-end.

• File final payroll taxes and W2 forms by January 31st to avoid penalties.

• States can have different procedures, so it's important to understand and comply with the specific dissolution requirements.

Benefits of Closing a Business Before Year-End

There are many licenses, permits, and registrations that require annual fees, such as franchise taxes and business licenses. These obligations can add up quickly, creating significant financial strain if not managed carefully. Additionally, many of these fees are unavoidable even if your business is no longer active, which is why it's so important to address these matters before the new year starts. Let's look closer at the details of how to minimize your tax liabilities.

Minimize Startup Taxes & Fees During Dissolution

It's worth noting that many states charge a franchise tax ranging from a few hundred to thousands of dollars for the right to do business in the state.

Franchise tax calculations are complex and vary wildly based on state, industry, and company structure.  Delaware, for example, has two methods for calculating franchise tax: the "Authorized Shares Method" and the "Assumed Par Value Capital Method." Using the wrong method can lead a company to pay hundreds of thousands of dollars when they might actually only owe the minimum amount. 

Some states allow companies that dissolve in a given year to pay a pro rata fee, but there is usually a minimum fee, which is often the same as a company would have to pay if it existed for the entire year. By completing the corporate dissolution process and addressing any outstanding liabilities before December 31st, you can avoid significant state taxes and other fees.

Filing Final Tax Returns for Business Closure

Many companies mistakenly believe that if they have no revenue or income, they do not need to file taxes, but this is not true. Even if a company has no activity, it must still file a tax return, sometimes called a "zero return."

If there is any income, fines and penalties will be charged as a percentage of the amount of tax due. However, even without any activity, the IRS or state taxation agency will still expect a return and may take action to force the company to file. This could result in unnecessary complications and fines, making it essential to complete all tax obligations during the dissolution process.

Employee & HR Requirements During Business Shutdown

Closing a business also involves fulfilling your obligations to your employees and ensuring that your state-level accounts are properly managed. This includes filing all necessary wage reports, even after employees have left the company. Companies are required to maintain accounts in states where they have employees for purposes such as withholding taxes. Even if a company no longer has employees in a state, that state may assume the company still has employees if wage reports are not properly filed.

Failing to properly close these accounts can lead to significant issues. Companies are frequently hit with unexpected bills for tens of thousands of dollars due to the assumption that they still have employees when, in fact, they do not. Sometimes these bills can be resolved without payment, but it requires significant time and effort—effort that could have been avoided if the company had properly shut down all accounts.

You must also submit final payroll information, complete all tax filings (including W2 forms by January 31st), and clearly communicate with your employees about their final pay and tax documents. Addressing any outstanding debts and closing all business accounts further minimizes the risk of disputes or financial issues after closure.

Canceling Permits & Licenses When Closing a Business

Depending on the industry and location of a company, they may hold permits or licenses at the city, county, or state level. For example, New York City even requires registrations at the borough level, which means businesses may need to manage multiple registrations depending on where they operate.

Tech companies and startups often need to register for a variety of specific permits and licenses, especially if they deal with data or operate in regulated sectors. For instance, a startup dealing with cryptocurrency may need specific financial permits, while a drone technology company might require special FAA permits. Additionally, startups in health tech may need compliance certifications, such as HIPAA, depending on their services. If these permits or licenses are not properly canceled, the company could still be liable for fees or penalties even after operations have ceased.

How to Dissolve a Business: A Step-by-Step Guide

Closing your startup business involves several key steps. Here is a general overview of the main steps applicable to all business types:

1. Vote to Dissolve: Ensure that the decision to dissolve is formally agreed upon by all stakeholders or according to the company's operating agreement or bylaws.

2. File a Certificate of Dissolution: Submit the necessary paperwork to formally dissolve the company with the state.

3. Notify Stakeholders: Inform all relevant stakeholders, including employees, creditors, customers, and suppliers, about the closure.

4. Settle Debts and Obligations: Address all outstanding financial obligations, including debts to suppliers, lenders, and service providers.

5. File Withdrawals from States: File withdrawal notices in states where your business is registered to do business, outside of your original state.

6. Close State Agency Accounts: Properly close accounts with state agencies, such as unemployment insurance and state tax authorities.

7. File Final Tax Returns: Submit all final tax returns to the IRS and state tax agencies.

Settling Business Debts During Dissolution

Before closing, create a comprehensive list of all creditors, including suppliers, lenders, and service providers. Distribute your remaining assets fairly among them, review and negotiate the terms of any promissory notes or debt agreements, and obtain written agreements when settling debts to protect yourself from future claims. Consider creditor subordination agreements if necessary, which can help prioritize certain debts over others and facilitate smoother settlements. Note that certain mandatory creditor subordination requirements can be complex, adding further challenges during the settlement process. 

State-Specific Business Dissolution Procedures

The specific dissolution process varies depending on your business structure and state. In the following sections, we will cover some more specific scenarios.

How to Dissolve a Delaware Corporation

Shutting down a Delaware corporation is really a three-step process: dissolution, winding-up, and shutdown.

• Dissolution: This is the legal component that must be completed before December 31st to avoid next-year taxes and fees. Dissolution includes executing board resolutions, obtaining shareholder consents, creating a plan of dissolution, and filing a Certificate of Dissolution with the state. It is crucial to file the Certificate of Dissolution before December 31st, as even filing one day into the new year will trigger the requirement to pay the entire franchise tax and file tax returns. Once the dissolution is filed, the company legally exists but is no longer allowed to conduct business. However, as long as the Certificate of Dissolution is filed within a calendar year, the company will not need to pay franchise tax or file tax returns for the following year, and it has up to three years to complete the winding-up and shutdown steps.

• Winding-Up: After the dissolution step, the company enters the winding-up phase, during which it distributes remaining assets and settles any lingering business matters.

• Shutdown: This final step involves closing out all remaining accounts, and handling federal tax obligations.

The most important date for Delaware corporations is December 31 of the current year. Delaware typically sees a surge in filings at the end of the year as companies rush to avoid additional fees and taxes for the following year. The state often experiences delays of about four weeks, which can increase significantly during the end-of-year rush. However, expedited processing is available by paying an additional $100, which usually results in a response within three days. Keep in mind that Delaware does not accept filings on weekends or holidays, and their system can shut down unexpectedly, so it is important to allow plenty of time for filing.

Dissolving a Delaware LLC: What You Need to Know

Unlike corporations, Delaware LLCs must completely wind-up before filing for dissolution. This means all debts must be resolved, assets distributed, and registrations withdrawn before filing for dissolution. Since the company is not officially dissolved until you file with the state, the entire process must be completed before the end of the year.

While December 31 is the deadline to dissolve, make sure to give yourself plenty of time to wind up the company first. Using traditional methods, it can take about nine months to wind-up a company.

The key difference for LLCs is that all winding-up activities, including settling debts, distributing assets, and withdrawing registrations, must be fully completed before filing for dissolution. Properly managing this timeline is crucial to ensure the dissolution is effective and to avoid ongoing liabilities and fees.

California Corporation Dissolution: A Step-by-Step Guide

Unlike Delaware corporations, California corporations cannot file a Certificate of Dissolution with the state until the company is completely wound up. This means all debts must be resolved, assets distributed, and registrations withdrawn before filing for dissolution. Since the company is not officially dissolved until you file with the state, the entire process must be completed before the end of the year.

Although December 31 is the deadline to dissolve, it's crucial to allocate ample time to wind up the company beforehand. Traditionally, winding up a company can take around nine months. Ensure you factor in the time needed for these tasks when planning your dissolution timeline to avoid additional tax obligations for the upcoming year.

How to Dissolve an LLC in California

California LLCs must shut down in a three-step process similar to Delaware corporations. First, the company must vote to approve dissolution and then file a Certificate of Cancellation with the Secretary of State. "Cancellation" is the California LLC equivalent of "dissolution." After a California LLC is canceled, it can continue to wind up by canceling registrations, settling debts, and distributing assets to investors.

Unlike Delaware, California does not provide a specific timeframe for winding up, so a company must be actively working to shut down. Fortunately, you can avoid next year taxes and fees as long as the Certificate of Cancellation is accepted by December 31st. This means you can continue winding up the company next year as long as the company is canceled this year.

Wyoming LLC Dissolution: Key Steps and Deadlines

Wyoming LLCs follow a similar order of operations as California LLCs and Delaware corporations. First, the company must vote to dissolve and then file Articles of Dissolution with the state. After filing the Articles of Dissolution, the company can continue to wind up its affairs, including canceling registrations, settling debts, and distributing assets. To avoid additional franchise tax, it is crucial to file the Articles of Dissolution by December 31st, ensuring that the company is on track to shut down effectively.

Business Closure Deadlines: Avoid Penalties & Fees

Meeting deadlines is crucial for a smooth closure. Here are some specific deadlines to keep in mind for dissolving various types of businesses and avoiding fees for the following year:

• To avoid an additional year of franchise tax, the company must be closed with the Secretary of State of the state where it was incorporated by December 31st.

• Some states require certain business types to completely wind up before filing, while others allow winding up after filing. See the sections above for details on each state and entity type.

Tax Deadlines: After dissolving, companies must file a final tax return by the 15th day of the fourth month following the dissolution. For payroll taxes and W2 forms, the deadline is January 31st.

Make sure to also settle all outstanding debts, close business accounts, and communicate clearly with employees about their final pay and tax documents.

Important Factors to Consider During Business Dissolution

Dissolving a Business with Debt: What To Do

If you have outstanding debts, it is essential to understand your legal responsibilities when dissolving a business. Prioritize creditors based on secured (those with collateral) and unsecured debts. If there are insufficient assets to cover all debts, each creditor is entitled to a pro rata share of the remaining assets. For example, if a company owes $50,000 to Creditor A and $100,000 to Creditor B but only has $75,000 in assets, Creditor A would receive $25,000 and Creditor B would receive $50,000.

Investments made through promissory or convertible notes are considered debts and must be included in this calculation. Certain types of debt, such as secured debts, are paid before unsecured debts, and employee claims generally take precedence over other unsecured debts.

Officers and directors are usually shielded from liability, but they could be held personally liable if assets are distributed incorrectly. Creating an inventory of assets and debts, notifying creditors, negotiating settlements, and seeking legal advice are all crucial steps to properly settle debts and avoid personal liability.

Distributing Business Assets During Dissolution

After paying debts and expenses, any remaining assets should be distributed to the shareholders of the company. This process, typically called the 'waterfall,' involves prioritizing preferred shareholders over common shareholders. In short, common shareholders do not receive payment until preferred shareholders have recouped their initial investment. Companies often issue multiple classes within each shareholder category, so consult your governing documents (e.g., Certificate of Incorporation, Bylaws, LLC Agreement) for specific procedures that apply.

Need Help Closing Your Business? SimpleClosure Can Help

Our startup veterans make shutting down stress-free. With our experienced team, streamlined technology, and tailored solutions, we handle every detail so you can move forward with confidence.

Simple as 1-2-3, SimpleClosure makes shutting down your business straightforward and stress-free:

• We Learn About You: By answering a few questions, you'll provide us with everything we need to put together the ideal shutdown plan for your startup.

• We Handle It All: You're matched with an experienced Dissolution Expert who will guide you through your customized plan and keep you updated throughout the process.

• You Move On: Track your shutdown progress while focusing on your next opportunity. We'll ensure everything is taken care of, giving you peace of mind.

Closing a Business: Take Action Before Year-End

Closing your business before January 1st requires careful planning and attention to detail. By following the steps outlined in this article and utilizing the resources provided, you can navigate the dissolution process smoothly and start fresh in the new year.

Business Dissolution Resources: IRS, SBA, & More

• IRS Closing a Business Checklist - A comprehensive checklist from the IRS to ensure you meet all federal tax obligations when closing a business.

• SBA Business Guide on Closing Down - Guidance from the Small Business Administration on how to close your business properly.

• Delaware Division of Corporations Dissolution Guide - Specific information on dissolving a corporation or LLC in Delaware.

• California Secretary of State - Business Dissolution - A resource for dissolving California-based businesses, including forms and instructions.

• Simple Closure Blog - Winding Down a Startup - Practical advice and insights on the challenges of winding down a startup, including dealing with debts and asset distribution.