12.9 Small Business/Self-Employed/Other Business : Starting or Ending a Business

If you invest your personal funds to start a corporation, this is your basis in the stock of the corporation. Your stock basis will show on the balance sheet of the corporation's Form 1120 (PDF), U.S. Corporation Income Tax Return. Your investment will not show up on your personal income tax return until you sell the stock or until the corporation goes out of business.

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If you are starting or already have a small business and need information on taxes, recordkeeping, accounting practices, completing Federal business and employment tax returns, and meeting other Federal tax obligations, there is help available. Much of the assistance is free. The service is called Small Business Tax Education Program, or STEP. Go to Around the Nation for seminars in your area or check out Tax Info For Business on the IRS web site. You can find out more about this program for small business by referring to Publication 1066 (PDF), Small Business Tax Workshop, or Tax Topic 103 , Small Business Tax Education Program (STEP).

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The annual income tax forms that you would use to report you business activity to the IRS would depend on the type of entity you operate your business under.

If you have $400 or more of net profit from your business, you will have to file a Form 1040 with a Form 1040, Schedule C (PDF), Profit and Loss from Business (Sole Proprietorship) or Form 1040, Schedule C-EZ (PDF), Net Profit form Business and Form 1040, Schedule SE (PDF), Self-employment Tax .

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The Federal Income Tax return is filed annually. As a self-employed individual, if after deducting withholding and credits you expect to owe $1,000.00 at the end of the year, you should make estimated tax payments on a quarterly basis. Form 1040-ES (PDF) , Estimated Tax for Individuals , will assist you in determining if estimated tax payment are due and how they are paid.

When you file the income tax return at the end of the year, you include the income from the business on the return. The forms to be filed are Form 1040 (PDF), U.S. Individual Income Tax Return , Form 1040, Schedule C (PDF), Profit or Loss from Business Form 1040, Schedule SE (PDF), Self-Employment Tax . If estimated tax payments where made during the year, they will be claimed on the individual income tax return as payments. See the Form 1040, Line 62.

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When a sole proprietor ends a business, the last Form 1040, Schedule C (PDF), Profit or Loss from Business, filed for that business does not require notation as a final return because the business is not a separate entity from the sole proprietor. You simply quit filing a Schedule C with your income tax return.

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Generally inventory losses and gains must be run through the business (shown as sold on Form 1040, Schedule C (PDF), Profit or Loss from Business) when sold even after the business closes. If you cannot sell inventory because it has become obsolete or you have formed the intent to give up possession of the inventory without passing it on to someone else and suffer a loss, you may deduct such losses. If you use any remaining inventory for personal use after you go out of business, you cannot take a deduction for that inventory. If you give the remaining inventory away to a nonprofit organization, claim your deduction on Form 1040, Schedule A (PDF), Itemized Deductions. When you have business related expenses after your business has closed, you still may deduct these expenses.

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To determine which form you should file for your business entity, select one of the following links:

. Publication 541, Partnerships

. Publication 542, Corporations

. Publication 3402 (PDF), Tax Issues for LLC s

. Publication 334, Tax Guide for Small Business

. Entities: Sole Proprietor, Partnership, Limited Liability Company/Partnership (LLC /LLP), Corporation, Subchapter S Corporation

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If you are a partner in a partnership and have received a 1065 K-1, Please see Instructions for Form 1065, Schedule K-1 for help in preparing your form.

If you are a shareholder in an S-Corporation and have received a 1120S K-1, please see Instructions for Form 1120S, Schedule K-1 for help in preparing your form.

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In general, ordinary and necessary business expenses are deductible on business return. However, there are some items that partnership and S Corporation do not deduct at the business entity level but rather at the partner or shareholder level. These are referred to as separately stated items. For a more complete explanation of business in general, see Publication 535 , Business Expenses Publication 541, Partnerships, and Instructions for Form 1120S.

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The process for closing a corporation consists of many steps that need to be followed in a specific order and within specified time frames. See Small Business/Self Employed - Closing a Business for information to properly terminate your business entity with the Internal Revenue Service.

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The due date for a K-1 is the same as the due date of a Partnership or S Corporation return that created the K-1. For example, if you are a partner in a partnership and the partnership return has a due date of April 15, 2004, then the due date for the K-1 is also April 15, 2004. You may wish to file an extension if you do not believe you will receive your K-1 in time to adequately prepare your return.

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Corporation are formed at the state level first. For additional information on requirements at the federal level, please see Publication 542, on Corporation .

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The place where your loss is reported depends on how much is deductible, the type of loss, and the type of return you are filing. If your business deductions are more than your business income for the year, you may have a Net Operating Loss (NOL). You can use an NOL by deducting it from your income in another year or years. Partnerships and S Corporations generally cannot use an NOL. But partners or shareholders can use their separate shares of the partnership's of S Corporation's business deductions to their individual NOLs. For additional help, see Publication 541, Partnership, Publication 542, Corporation, Publication 925, Passive Activities and At-Risk Rules, and Publication 536, Net Operating Losses (NOLs) for individuals, Estates, and Trusts.

If you have a Capital Loss, it is generally from the sale or loss of investment property, a business, or a capital asset used in a business. Publication 544, on Sales and Other Disposition of Assets, will provide additional information on this subject.

Special Situations

S Corporations

In general, if an S corporation purchases a C Corporation at the end of the year and the C Corporation has a loss, the S Corporation does not get to claim the C Corporation loss. A C Corporation is a taxable entity in itself and gains and losses do not flow through to the shareholders.

S Corporation shareholder who hold stock at any time during the year may claim their proportionate share of corporate losses on their individual tax returns subject to certain limits. For more information about the limitations, see the instruction for Instructions for Form 1120S, Schedule K-1.

Partnerships

In general, a partner loss is allocated base on his/her percentage of ownership of the year. This percentage is referred to as the partner's distributive share. The partners' distributive share of items is reported to the partner on Schedule K-1 (Form 1065). A partner's distributive share of partnership loss is allowed only to the extent of the adjusted basis of the partner's partnership interest. A loss that is more than the partner's adjusted basis is not deductible. For additional deductibility of partnership losses, see Publication 541, Partnership, and Publication 925, Passive Activities and At-Risk Rules

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Subchapter C Corporation

This type of corporation can deduct capital losses only up to the amount of capital gains. If capital losses exceed capital gains, the excess is first carried back three years prior to the loss year and used to offset capital gains. Then, any unused loss is carried forward up to five years from the loss year to offset capital gains in those years. If the corporation is dissolved, the loss is not carried to any other year or return, it is simply lost.

A corporation may not carry a capital loss from or to a year in which it operates as a Subchapter S Corporation.

Rules for Carryback and Carryforward

When carrying a capital loss from one year to another, the following rules apply:

1. When figuring the current year capital loss, you cannot combine it with a capital loss carried another year. In other words, you can carry capital losses only to years that would otherwise have a net capital gain.

2. If you carry capital losses from 2 or more years to the same year, deduct the loss from the earliest year first.

3. You cannot use a capital loss carried from another year to produce or increase a net operating loss in the year to which you carry it back.

Corporation must include capital gain in full in gross but only to the extent they exceed capital losses. A corporation is taxed on net capital gain at the regular tax rate, including the additional phase-out rates for high-income corporations. See Instructions for Form 1120/1120A, U.S. Corporation Income Tax Return, and Publication 542, Corporations for additional information.

Subschapter S Corporations

An S Corporation generally passes gains and losses through to the shareholders based on their percentage of ownership (distributive share). For more information on how to calculate and report these losses, see Instructions for Form 1120S, Schedule K-1, Form 4797 (PDF), Sales of a Business, Form 1120S (PDF), U.S. Income Tax Return for an S Corporation, Entities: Sole Proprietorship, Limited Liability Company/Partnership (LLC /LLP, Corporation, Subchapter S Corporation.

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A partnership terminates when one of the following events takes place.

1. All operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership, or

2. At least 50% of the total interest in the partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner.

Regardless of the method of termination, the final Form 1065 (PDF) , U.S. Return of Partnership Income of a partnership and the corresponding Form 1065, Schedule K-1 (PDF) should be marked as "Final Return". This notifies the IRS that the partnership has been terminated. See Treasury Regulation 1.708-1 (b) for additional information on the termination of a partnership.

The partnership's tax year ends on the date of termination. If a partnership is terminated before the end of the tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. Publication 541 Partnership, for additional information.

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If you an unincorporated business by yourself, you are considered a sole proprietor. However, if you are the sole member of a domestic limited liability company (LLC ), you are not a sole proprietor if you elect by filing Form 8832 (PDF) , Entity Classification Election, to treat the LLC as a corporation.

An husband or wife may be sole proprietor with the spouse an employee.

An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if it members carry on a trade, business, financial operation or venture and divide its profits.

If a husband and wife jointly own and operate a business and share in the profits and losses, they are partners in a partnership.

The following businesses are taxed as corporations:

Some forms and entities have due dates other than the well-known April 15th due date. The instructions for the each type of form used will have the appropriate due date(s) noted. In general, sole proprietor's schedule of income and expenses is attached to the 1040. Therefore, the due date is the same as the 1040.

A Corporation must generally use the calendar year, unless the entity can establish a business purpose for having a different tax year. The due date is usually March 15th.

A partnership generally must conform its tax year of the partners unless the partnership can establish a business purpose for having a different tax year. The tax year is the same as one or more partners that own (in total) more than a 50-percent interest in partnership profits and capital. If there is no majority interest tax year, the partnership must adopt the same tax year as that of its principal capital holder. Where neither condition is met, a partnership must use the calendar year. A limited Liability Company reporting as a partnership has the same tax year as a majority of its partners.

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Unfortunately, the answer to this question has many variables. Publication 541, Partnerships "Disposition of Partner's Interest" on Partnerships should provide the information needed.

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