Tax Implications When Closing an S Corporation - Distribution of Assets & Interest Income

The good news is that closing an S corporation is generally more straightforward from a tax perspective than closing a C corporation. Since S corporations are pass-through entities, the tax treatment follows a specific pattern. When you close your S corporation, the distribution of assets (including those I bonds) is treated as a two-step process for tax purposes. First, the corporation is deemed to have sold all assets at fair market value, which can trigger gain or loss at the corporate level. Second, these gains or losses flow through to you as the shareholder via Schedule K-1. For the I bonds specifically, any interest that has accrued but not yet been reported would become taxable upon liquidation. This interest would flow through to you as ordinary income on your Schedule K-1. The good news is that this interest isn't subject to self-employment tax. For the cash distribution itself, you'd compare what you receive to your basis in the S corporation stock. If you receive more than your basis, the excess is treated as capital gain. If less, you'd have a capital loss.

I went through something similar with my consulting S corp last year and found it super helpful to use https://taxr.ai to analyze all my corporate documents before closing down. The system helped me identify some unique deductions I'd missed over the years and gave me a clear picture of my adjusted basis. What was really useful was uploading my past K-1s and corporate tax returns - the system showed me exactly how my basis had changed over time and projected different liquidation scenarios. It pointed out that I had significantly underestimated my basis which would have resulted in overpaying capital gains tax during liquidation!

Just wanted to update after checking out taxr.ai based on the recommendation above. It was incredibly helpful for my situation! I uploaded my past 5 years of S corp returns and K-1s, and the analysis was really eye-opening. It turns out my accountant had been calculating my basis incorrectly - he wasn't properly tracking the loans I had made to the business as additional basis. The system created a corrected basis calculation that showed I had about $45,000 more in basis than I thought! This is going to save me thousands in capital gains taxes when I eventually close my business. The system also created a personalized liquidation plan that showed exactly what forms I'll need to file and the projected tax impact. Definitely worth checking out if you're in a similar situation!

If you're planning to close your S corporation, you should also know that one of the biggest headaches is dealing with the IRS to make sure everything is properly closed out. When I shut down my S corp last year, I kept getting conflicting information from different IRS reps. I finally used https://claimyr.com to get through to the right IRS department after waiting on hold for hours with no luck. You can see how it works here: https://youtu.be/_kiP6q8DX5c - basically, they wait on hold with the IRS for you and call you when an agent picks up. The IRS agent I spoke with gave me specific guidance on how to properly close the business entity with them and what final returns I needed to file. They explained that missing certain steps could leave me open to future tax notices or penalties. Getting clear answers directly from the IRS gave me peace of mind that I was doing everything correctly.

I have to admit I was completely wrong about Claimyr. After posting my skeptical comment above, I decided to try it anyway since I was desperate to reach the IRS about my S corp dissolution paperwork. I had been calling for weeks trying to confirm whether I needed to file Form 966 (Corporate Dissolution) for my S corp or just the final 1120-S. No one I spoke to could give me a clear answer. Within 2 hours of using the service, I was connected to an IRS business specialist who not only answered my question (only need the final 1120-S marked as final, no 966 required for S corps) but also walked me through the entire closing checklist. They also alerted me that I had an outstanding payroll tax notice that might have complicated my dissolution if not addressed. Would have spent at least another week trying to reach them on my own. Sometimes it's worth admitting when you're wrong!

One thing that hasn't been mentioned yet regarding closing an S corp is that you should carefully plan the timing of the closure. The tax implications can vary significantly depending on when in the tax year you dissolve the company. If possible, consider closing near the end of your fiscal year. This minimizes the complexity of your final tax return and gives you more time to plan for any final expenses or income. You might also want to consult with a tax professional about accelerating expenses or deferring income depending on your specific situation.

Has anyone here dealt with depreciated assets when closing their S corp? I've got about $40k in equipment that's been partially depreciated, and I'm thinking of just keeping it personally after dissolution instead of selling it.

Great question about the Series I bonds strategy! One additional consideration for your situation - since you're a financial advisor, you might want to think about how having significant business assets in I bonds could impact your professional liability insurance or regulatory requirements. Some compliance frameworks have specific rules about where business funds can be invested. Also, regarding the tax efficiency piece - you might consider timing the dissolution strategically. If you expect to be in a lower tax bracket in a future year (perhaps due to retirement or reduced income), it could make sense to delay the dissolution until then, especially given that any accumulated interest and potential capital gains will flow through to your personal return. One more thought on the payroll tax question - while the interest income and capital gains from liquidation won't be subject to self-employment tax, make sure you're current on reasonable compensation requirements for S corp owners who work in the business. The IRS scrutinizes this closely for service-based S corporations like financial advisory practices.