Shutting Down A Sole Proprietorship

Shutting Down A Sole Proprietorship

Are you considering dissolving your sole trader business or single-member limited liability company? When implementing such a major change in the business, any business owner must take the time to understand the tax implications. If you manage your time well and are strategic, you can reduce the amount that you give to the government and make the process seamless. In this article, you will learn about the important aspects of taxes when closing your business.

Understanding the Asset Sale Treatment

When you close your sole proprietorship or single-member LLC, the IRS will consider the sale as the sale of the business assets rather than the business entity. What this implies is that you will have to assign the total sale price to the individual assets sold, so as to get your taxable gains and losses.

Allocating the Sale Price

To achieve this, the sale price should be split among the different business assets in a manner that will help reduce your liability to the tax man. Overall, you should assign a higher proportion of the price to items that qualify for lower-taxed LTCG, such as land, buildings, and purchased intangibles. Conversely, reduce the amount that would generate high-taxed ordinary income, such as receivables, inventory, and fully depreciated or amortized furniture, equipment, and purchased intangibles.

Taxation of Depreciable Assets

In the case of the disposal of depreciable or amortizable assets, you will need to determine the amount of taxable gain or loss. It is important to learn that a gain is taxed where the sale price is higher than the tax basis of the asset, while a loss is deductible where the sale price is lesser than the tax basis of the asset. Those arising from depreciation or amortization are taxed at higher ordinary income rates, while the residual amount on other assets held for over one year is taxed at more favorable Section 1231 long-term capital gain rates.

Special Rules for Depreciable Real Estate

Real estate that is depreciable is governed by certain tax laws. According to Section 1250, gains equivalent to the extra depreciation claimed for the property are classified as high-taxed ordinary income. Any amount over the ordinary recapture amount is considered a Section 1231 gain, which is subject to lower capital gains tax rates. Further, any Section 1250 gain that has not been captured and taxed as Section 1231 gain is taxed at a 25% flat rate except if the rate is lower in accordance with the income level.

Favorable Treatment for Section 1231 Assets

Section 1231 assets, especially business real estate, depreciable assets and amortizable intangibles, which have been held for more than one year, have special treatment. The net gain is taxed at the reduced long-term capital gains rates if the aggregate of Section 1231 gains for the year is more than the total Section 1231 losses. However, where Section 1231 losses are greater than the gains, the net loss is considered a conventional loss as far as tax computation is concerned. However, there is something that you need to understand about the nonrecaptured Section 1231 loss rule, which affects future Section 1231 gains.

Tax Treatment of Self-Created Intangibles and Non-Compete Agreements

Sales of self-created intangible assets such as patents, inventions, and secret formulas are taxed as ordinary income. Similarly, payments that are received under the non-compete agreement with the buyer of the business are also categorized as high-taxed ordinary income. However, non-compete payments are not subjected to self-employment taxes.

Additional Tax Considerations

If you are selling your business assets, there are chances that you will be taxed under self-employment tax for the gains from the sale of receivables or inventory. The 3. 8% NIIT may also apply to certain passive gains. Here are some of the standard IRS forms that should be used to report taxes correctly: Form 4797 for asset sales, Form 8594 for asset divisions, Schedule SE for self-employment tax, and Form 8960 for NIIT, among others.

Conclusion

Closing your sole proprietorship or single-member LLC has legal and tax considerations that you have to consider. Knowing how the asset sale treatment works, how to optimally assign the sale price, and the tax implications of various types of assets will allow you to reduce your taxes and have a smooth transition. It is always advisable to seek the assistance of a tax consultant to help you with the intricacies of your business shutdown plan.