Closing a Texas LLC or Corporation That Owes the IRS

Owners close businesses for all sorts of reasons. When the business owes the IRS, the temptation is to shut it down, terminate the entity, and hope the debt dies with it. Sometimes the entity's debt does become practically uncollectible. But the owners' exposure often survives, and a sloppy shutdown creates new exposure that did not exist before.

The Texas side, briefly

Texas entities wind up and terminate under the Texas Business Organizations Code, typically by filing a certificate of termination with the Secretary of State. The Comptroller's franchise tax rules generally require the entity to be current on franchise tax before it can terminate. An entity that stops filing franchise tax reports can also lose its right to transact business or have its charter forfeited.

Those are Texas procedures, and an owner should follow them with help from a Texas business attorney or CPA. Texas law also provides that certain claims can survive against a terminated entity for a limited period. None of it controls how the IRS collects federal taxes.

Final federal returns

The IRS needs to know the business is closing. That means final returns, clearly marked:

• Income tax. Form 1120 or 1120-S for a corporation, or Form 1065 for an LLC taxed as a partnership, with the final return box checked, filed for the year the business ends. A single-member LLC that is disregarded reports its final year on the owner's Schedule C or E.
• Form 966. Under IRC 6043(a), a corporation that adopts a resolution or plan to dissolve or liquidate generally must file Form 966 within 30 days after adoption.
• Payroll. A final Form 941 for the last quarter wages were paid, with the box indicating the business closed, a final Form 940, and Forms W-2 and W-3 for the final year.
• Information returns. Forms 1099 for payments to contractors in the final year.
• Distribution reporting. Corporations that make liquidating distributions report them to shareholders on Form 1099-DIV.

Skipping these filings leaves the IRS assuming the business is still operating. It keeps sending notices, may prepare substitute assessments, and eventually assigns a revenue officer to find out what happened.

Once final returns are filed and balances are paid, the IRS can close the business accounts associated with the EIN. The EIN itself is never reassigned.

What happens to the entity's tax debt

Terminating a Texas entity does not erase its federal tax liabilities. The IRS can still assess within the normal statute of limitations and collect from any assets the entity still owns or that can be traced. In practice, a closed company with no assets often becomes uncollectible as to the company itself.

Unfiled returns are their own problem. If the entity stopped filing before it stopped operating, the IRS may prepare substitute assessments or simply keep the periods open. The assessment statute generally does not start running on a return that was never filed. Filing the missing returns, even late, starts those clocks and gives the IRS accurate numbers instead of estimates. My guide on unfiled tax returns explains how to catch up.

That is where owners stop paying attention, and that is the mistake. The IRS's next move is to look at the people.

Trust fund taxes follow the responsible people

If the business owes payroll taxes, the withheld portion, employees' income tax and their share of Social Security and Medicare, can be assessed personally against every responsible person who willfully failed to pay it, under IRC 6672. Closing the entity does not stop that. In fact, revenue officers often pursue the trust fund recovery penalty precisely because the business has closed and has nothing left to levy.

My guide on the trust fund recovery penalty covers the responsible person and willfulness tests, and how to respond to a Letter 1153.

Distributions to owners: the transferee trap

Here is the part most people miss. When an entity owes the IRS and its owners take the remaining cash, equipment, or receivables on the way out, they may become transferees. IRM 5.17.14.3.3.5 explains that shareholders who receive assets in a corporate liquidation can be liable as transferees for the corporation's unpaid taxes, generally up to the value of what they received, and that distributions short of liquidation, or excessive compensation to an owner, can also create transferee exposure.

The IRS can assess that liability under IRC 6901 without a lawsuit, or sue to set the transfers aside. My guides on transferee liability and fraudulent transfers in Texas cover both routes.

So the order matters. Pay creditors, including the IRS, before distributing anything to owners. If the entity cannot pay everyone, get advice on priorities before writing a single check to an owner. Federal law also has a priority statute, 31 U.S.C. 3713, that can make a person who pays other debts ahead of federal claims from an insolvent estate personally liable in some circumstances.

A clean shutdown checklist

• Pull the entity's IRS transcripts for every tax type and period, and identify every balance and unfiled return.
• Stay current on payroll deposits through the last paycheck.
• File every final federal return and Form 966 where required.
• Sell assets for fair value and document it.
• Apply proceeds to creditors, including the IRS, before any owner distributions.
• Address trust fund exposure for responsible people directly, including whether to designate payments to the trust fund portion.
• Complete the Texas termination steps with a Texas professional who handles that area.

Ending a business is hard enough. Ending it in a way that leaves the owners personally liable for taxes they thought belonged to the company is worse, and it is avoidable. If you are winding down a Texas business that owes the IRS, let's plan the exit before you file the termination: 813-229-7100. The firm's payroll tax page has more on trust fund exposure, and my payroll tax guide for Dallas businesses covers the basics.