You’ve decided to close the S-corp. Maybe you’re retiring, maybe the business ran its course, maybe you sold the operating side and the shell needs to wind down. Whatever the reason, there’s a sequence to follow. Skip steps and you create tax surprises and state penalties that hit years later.
Distributing the assets is the taxable event
When the corp distributes its remaining assets to you (the shareholder), the IRS treats it as a sale at fair market value. Two layers of tax to think about:
- Corporate-level gain. The corp recognizes gain on any appreciated assets (real estate, equipment, etc.) at the time of distribution. This gain flows through to your K-1.
- Shareholder-level gain. You’re treated as receiving the FMV of those assets in exchange for your S-corp stock. The difference between the FMV received and your stock basis is capital gain (or loss).
If most of what’s left in the corp is cash, the math is simple: distribute cash, reduce basis, recognize gain on any excess. If there’s real estate or equipment with appreciation, plan carefully.
The order of distribution
If you have multiple classes of asset to distribute, the order matters for character of gain:
- Cash first (no gain).
- Marketable securities (gain recognized at FMV).
- Real estate (gain recognized; may be capital gain or § 1250 with unrecaptured § 1250 at 25%).
- Equipment (§ 1245 ordinary recapture on depreciation; capital gain on excess).
- Intangibles like goodwill (typically capital gain).
The Post-Termination Transition Period
For about one year after S-corp termination, you can still pull money out of the corp as tax-free distribution from AAA (Accumulated Adjustments Account). This is the "PTTP" and it can be used for a clean wind-down. After the PTTP closes, any further distributions are C-corp dividends.
The final returns and filings
- Final Form 1120-S. Mark the “Final return” box. Due 2 months 15 days after the end of the short tax year.
- Final K-1s to each shareholder.
- Final state corporate return. Usually requires a tax clearance certificate before dissolution.
- Final payroll filings. 941/944 for the final quarter, W-2s and W-3 for the year, state withholding closing returns.
- Form 966 (Corporate Dissolution or Liquidation) within 30 days of the dissolution resolution.
- Articles of Dissolution filed with the state.
- Cancel licenses and EIN. The EIN doesn’t officially "cancel" but you write to the IRS to close the business account.
The trap to avoid
If you stop filing without formally dissolving, you accumulate state minimum franchise taxes and penalties for years. Many states will not let you officially dissolve until you’re current on all taxes and filings. Plan to handle the state filings first, then the federal.