BILL ANALYSIS Ó
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 1143 HEARING: 6/5/13
AUTHOR: Skinner FISCAL: Yes
VERSION: 4/22/13 TAX LEVY: No
CONSULTANT: Grinnell
TAX ADMINISTRATION: SUSPENSION OR FORFEITURE: LIMITED
LIABILITY COMPANIES
Applies contract voidability law that applies to foreign
corporation to foreign LLCs.
Background and Existing Law
Corporations in California form by filing articles of
incorporation with the Secretary of State. Before
transacting intrastate business in California, a
corporation formed elsewhere must first qualify and
register with the California Secretary of State. A foreign
business entity can also qualify and register to transact
business in California by filing the appropriate forms with
the California Secretary of State. California law requires
corporations and limited liability companies to update the
records of the California Secretary of State on an annual
or biennial basis by filing a statement. Franchise Tax
Board (FTB) or the Secretary of State can suspend a
corporation for:
Failure to pay an amount due,
Failure to file a statement of information with the
Secretary of State's office, or
Failure to file any past due returns.
A suspended or forfeited business entity loses the right to
enforce its legal contracts, known as "contract
voidability." The counterparty to a contract with a
suspended entity may seek to void the contract by filing
suit against the suspended corporation. If a business
enters a contract while suspended or forfeited, and then
revives its active legal status, the business still cannot
enforce that contract unless it gets relief from contract
voidability by applying to FTB. Contract voidability is
only found in state law; federal law does not allow for it.
AB 1143 - 4/22/13 -- Page 2
A limited liability company (LLC) is a hybrid between a
corporation and a partnership. LLCs are generally a
partnership for operational and taxation purposes, although
California imposes a specific fee on LLCs, but its members
enjoy the immunity provided by a corporation to its
shareholders for contract debts or tort liability. The
interest of a member in an LLC is an economic interest, in
the same manner that a partnership interest or a corporate
share is an economic interest, that may be transferred
under terms and conditions provided by the LLC agreement,
the partnership agreement, or the corporate structure.
California first recognized LLCs in 1994 with the enactment
of the Beverly-Killea Limited Liability Company Act which
provided comprehensive provisions for the organization,
management, and dissolution of LLCs (SB 469, Beverly,
1994).
Foreign corporations are subject to contract voidability:
if they have an FTB account number contract voidability
commences within 60 days of FTB mailing a final notice, if
not, it begins on the first day of the taxable year in
which the foreign corporation failed to file a return.
However, foreign LLCs are not subject to contract
voidability at all.
Proposed Law
Assembly Bill 1143 adds foreign limited liability companies
onto the list of
corporations that are subject to contract voidability, and
specifies that it commences identically to current
treatment of foreign corporations. The measure also makes
a technical and conforming change.
State Revenue Impact
According to FTB, AB 1143 results in revenue increases of
$50,000 in 2013-14, $30,000 in 2014-15, and $50,000 in
2015-16.
Comments
AB 1143 - 4/22/13 -- Page 3
1. Purpose of the bill . According to the author, "In
1994, the Legislature authorized the formation of limited
liability companies (LLCs) in California by enacting the
Beverly-Killea Limited Liability Company Act. LLCs
organized within California are required to register with
the Secretary of State (SOS) and to pay taxes to the
Franchise Tax Board (FTB). Out-of-state LLCs who do
business in California are supposed to register with the
SOS and pay taxes to the FTB. However, out-of-state LLCs
do not always register with the SOS and do not always pay
taxes to the FTB. In these cases, the penalties for not
paying taxes cannot be enforced because of a loophole in
the law. AB 1143 would close this loophole.
Companies organized within California are termed
"domestic," while companies organized beyond California are
termed "foreign." Companies that are registered with the
SOS are termed "qualified," while companies that are not
registered with the SOS are termed "nonqualified." All
domestic LLCs are qualified, but not all foreign LLCs are
qualified, though they are supposed to be. Foreign
nonqualified LLCs can still pay taxes to the FTB even if
they are not registered with the SOS, but not all of them
do. When domestic and foreign qualified LLCs fail to pay
taxes, penalties, fees, or interest, or when they fail to
file required tax returns, they are subject to "contract
voidability." When an entity is subject to contract
voidability, any contract entered into may be voided by
another party to the contract, which is a significant
penalty for any business. While domestic and foreign
qualified LLCs are subject to this penalty, foreign
nonqualified LLCs were inadvertently not included. This
contract voidability penalty is also applied to all
corporations under the same tax situations. Contract
voidability even applies to foreign nonqualified
corporations. In fact, foreign nonqualified LLCs are the
only group of LLCs or corporations that is excluded from
the contract voidability penalty. The law does not treat
foreign nonqualified LLCs in the same manner as it treats
other LLCs and corporations in regards to contract
voidability, resulting in inequitable treatment between
similarly situated business entities."
2. Equity . AB 1143 advances horizontal equity by applying
the same rules of contract voidability to foreign LLCs that
currently apply to foreign C-Corporations. Horizontal
equity is one of the key values of any tax system:
AB 1143 - 4/22/13 -- Page 4
taxpayers with the same amount of income should pay the
same tax, and be subject to the same rules. Without
horizontal equity, tax systems distort economic decisions
as taxpayers make different decisions that they would have
to take advantage of differences. When California created
LLCs in 1994, the Legislature was concerned that taxpayers
would choose to form them instead of C-Corporations because
of tax and corporate reasons, and imposed a fee on LLCs
that sought to equalize the tax difference. While the
Legislature subsequently abandoned horizontal equity for
LLCs when it changed the fee to eliminate this
equalization, taxpayers are choosing the LLCs form instead
of C-Corporations: LLCs have grown in number from 26,186
in 2000-01 to 75,018 in 2012-13, and while S-Corporations
have also grown, fewer C-Corporations file returns today
than they did in 2000, suggesting that the California
Corporation Tax lacks horizontal equity as taxpayers find
an advantage in forming LLCs.
3. Urgency . AB 1143 is an urgency measure that takes
effect immediately. As such, Legislative Counsel has
assigned the measure the 2/3 vote key under Section 8(d) or
Article IV of the California Constitution.
Assembly Actions
Assembly Revenue and Taxation8-0
Assembly Appropriations 17-0
Assembly Floor 73-0
AB 1143 - 4/22/13 -- Page 5
Support and Opposition (05/30/13)
Support : Franchise Tax Board, California Federation of
Teachers, California Tax Reform Association, SEIU
California.
Opposition : None received.