An inactive business is a business that still exists but has no activity, which means no business transactions during a specific year. A business is not inactive if it conducts even minor transactions, or if it receives payments during a year from previous business transactions. Even if the business has no income, it may still be considered active for tax purposes.
There are many reasons a business may become inactive. One very common reason is that the original owner sets up an LLC to sell products or services online, but after a year or so loses interest in the business due to a lack of sales. That owner may want to keep the business in the hopes of relaunching it but doesn't want to put any time or expenses into it. The business becomes inactive.
Income Taxes and Business Type
You may need to file a tax return if your business is inactive or had no income for the year, depending on your business type.
Sole Proprietor on Schedule C
Since a sole proprietor is not registered with a state, there are no state fees that must be paid. If your sole proprietorship business has no profit or loss during the full year, it's not necessary to file a Schedule C for that year. But if you receive payments such as insurance that relate to the business, you must report those payments on a Schedule C.
A domestic partnership (one formed in the U.S.) must file an information return (Form 1065) if it receives gross income or had any transactions that affect deductions or credits for federal tax purposes. A foreign partnership generally must file an information return if it has gross income effectively connected with a U.S. business, or income from sources in the U.S., or it is making an election to amortize organization expenses.
A domestic corporation or S corporation (formed in the U.S.) must file an income tax return whether it has taxable income or not unless it's exempt from filing. A foreign corporation generally must file an income tax return for a variety of reasons.
Limited Liability Companies
Since LLCs are registered with a state, they must conform to the same requirements as partnerships and corporations for filing information returns (above).
Don't forget about self-employment tax, the tax you must pay on business income for Social Security and Medicare. Even if your business is inactive, any business income or payments you receive during a year must be reported for self-employment tax purposes.
What Are the Penalties for Not Paying Taxes?
If your business is inactive, and you must file an income tax return, you can be penalized for not filing. Business owners who do not file a tax return potentially face penalties at both the state and federal level.
- Federal: The IRS may penalize your business for not filing a federal tax return. The failure-to-file penalty is usually five% of the tax owed for each month or partial month your return is late, up to a maximum of $25%. Even if you had little or no income for a year, the IRS could still assess a penalty.
- State: Your state may also penalize your business for not filing a state tax return, and some states penalize businesses for being "inactive."
Do I Have to Notify the IRS or Anyone Else?
There is no formal notification process for the IRS. Since most business types (corporations, partnerships, and LLCs) are set up through a specific state, you will need to notify your state that your business is inactive.
Most states require an annual or biennial report or a state business tax for businesses registered with the state (corporations, S corporations, LLCs, and different types of partnerships). Check with your state's business department (usually this department is under the state Secretary of State) for more information.
Can a Business Stay Inactive?
There is no legal requirement that you end an inactive business, but at some point, you will probably want to stop filing federal and state tax returns and avoid paying annual fees and possibly penalties to your state for being inactive.
How Do I End an Inactivity?
The process of ending a business depends on the type of business. Corporations, LLCs, and partnerships registered with a state must go through a formal process of dissolution with the state.
Can I Cancel my Employer ID Number (EIN)?
Another way to formally end a business is to close your Employer ID account. The IRS says you can't cancel an EIN, but you can close your business account. Send a letter to the IRS with your information, EIN, and the reason for closing the account. Address the letter to "Internal Revenue Service, Cincinnati, OH 45999."
Read more about the steps of ending a business.
Disclaimer: The information in this article and on this site is intended to be general in nature, and is not intended to be considered as tax or legal advice. Every business situation is unique and laws, taxes, and regulations change. Before you make any legal or tax decisions, be sure to consult your tax and legal advisors.