BILL ANALYSIS                                                                                                                                                                                                    Ó




                                                                  AB 1143
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          CONCURRENCE IN SENATE AMENDMENTS
          AB 1143 (Skinner)
          As Amended  June 9, 2014
          2/3 vote.  Urgency
           
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          |ASSEMBLY:  |73-0 |(May 13, 2013)  |SENATE: |36-0 |(August 4,     |
          |           |     |                |        |     |2014)          |
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           Original Committee Reference:    REV. & TAX.  

           SUMMARY  :  Provides that a foreign nonqualified limited liability  
          company (LLC) is subject to contract voidability provisions if  
          it has failed to file a required tax return with the Franchise  
          Tax Board (FTB) or pay the amount of state tax due.  

           The Senate amendments  :

          1)Make a technical clarifying change to property tax law, by  
            replacing the term "lien date" with "valuation date" for  
            purposes of the comparable sales valuation method.  

          2)Require that the regulations issued by the FTB, related to the  
            classification of a business entity for income tax purposes as  
            either a partnership or a corporation, be consistent with the  
            federal regulations as in effect on May 1, 2014. 

          3)Clarify that the contract voidability provisions, with regard  
            to a limited liability company, apply for the period that ends  
            either on the date the taxpayer qualifies to conduct business  
            in California or the date the taxpayer obtains an account  
            number from the FTB, whichever is earlier.  

          4)Revise the urgency provision to specify that a necessary  
            federal law reference for the classification of a business  
            entity for state corporate income tax purposes needs to be  
            updated as soon as possible. 

           EXISTING LAW  :

          1)Authorizes the creation of various business entities,  
            including corporations and LLCs.  Provides that all  
            corporations and LLCs, which are either doing business in  
            California, or incorporated or registered and qualified by the  









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            Secretary of State (SOS) to do business in California, must  
            file appropriate income tax returns or information returns and  
            pay the appropriate tax, penalties, and interest.  

          2)Requires every domestic and registered foreign LLC and  
            corporation to file a Statement of Information with the SOS,  
            within 90 days after the filing of its original Articles of  
            Organization or Application for Registration, and biennially  
            thereafter, during the applicable filing period.  Imposes a  
            penalty for failure to file the Statement of Information with  
            the SOS by the due date.  

          3)Authorizes the FTB to suspend a corporation's and an LLC's  
            powers, rights, and privileges for non-payment of fees due or  
            non-filing of tax returns.  (Revenue and Taxation Code (R&TC)  
            Sections 23301 and 23301.5).

          4)Subjects corporations and LLCs, other than foreign  
            nonqualified LLCs, to contract voidability for failure to file  
            required tax returns or to pay taxes, penalties, fees, or  
            interest.   (R&TC Section 23304.1).

          5)Allows business entities that are subject to contract  
            voidability to obtain relief by paying all the tax due, filing  
            required tax returns and following certain specified  
            procedures. (R&TC Section 23305.1).   

           AS PASSED BY THE ASSEMBLY  , this bill:
           
           1)Clarified the existing definition of a "taxpayer" for purposes  
            of the contract voidability provisions to include a business  
            entity that is:

             a)   Organized as an LLC under a statute or law, a state or a  
               federally recognized Indian Tribe, or another jurisdiction;  
               or

             b)   Identified in the FTB regulations as being organized  
               under the laws of a foreign country as an LLC. 

          2)Specified that the contract voidability provisions, with  
            regard to an LLC, are applicable beginning on January 1, 2014,  
            or the first day of the taxable years for which the taxpayer  
            has failed to file a return, whichever is later. 










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          3)Made other conforming, technical changes.  

          4)Included an urgency provision stating that bill would take  
            effect immediately. 
           
          FISCAL EFFECT  :  According to the Assembly Appropriations  
          Committee, the FTB staff estimates that this bill will result in  
          an annual revenue gain of $30,000 in fiscal year (FY) 2013-14,  
          $80,000 in FY 2014-15, and $20,000 in FY 2015-16.

           COMMENTS  :   

          1)Author's Statement.  The author states that, "When domestic  
            and foreign qualified (registered with the state) 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.

          "AB 1143 closes a loophole for foreign LLCs not registered with  
            the state, thereby subjecting them to the same contract  
            voidability laws as other LLCs and as all corporations.   
            Making this change will provide an additional incentive for  
            foreign nonqualified LLCs to register with the Secretary of  
            State and to stay current with their state tax obligations, as  
            well as provide greater protections to California consumers."  
           
          2)Arguments in Support.  The proponents of this bill state that  
            it is important to ensure that "LLCs are registered and paying  
            their appropriate taxes to California."  They believe that  
            existing law is not sufficiently clear as to whether an  
            out-of-state LLC may be compelled to register in California  
            and pay the LLC fees.  Thus, the proponents argue that this  
            bill is needed to "close any potential loophole that loses tax  
            revenue and advantages out-of-state companies."

          3)Background:  What is an LLC?  SB 469 (Beverly), Chapter 1100,  
            Statutes of 1994, authorized formation of LLCs in California.   
            An LLC is a business entity formed by members by filing a  
            document, usually called "Articles of Organization," with an  
            officer designated by state law.  An LLC combines aspects of  









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            partnerships and corporations, so an LLC is less formal and  
            more flexible than a typical corporation, yet offers  
            protection as well as certain advantages that are much the  
            same.  For example, LLC owners have limited liability for the  
            entity's debts and obligations, similar to the status of  
            shareholders in a corporation.  Their assets are separate from  
            the assets of the LLC so they cannot be seized.  Members of  
            the LLC may choose for the LLC to be taxed as a regular  
            corporation or as a partnership, where the income and losses  
            are normally passed through to the owners.  Flow-through  
            taxation is advantageous since members are only required to  
            pay taxes on their earnings once, instead of paying both  
            corporate and individual taxes. 

            The Legislature feared that the federal tax benefits conferred  
            by LLC status would lead many businesses to change to the LLC  
            form and would provide an incentive for new businesses to  
            choose LLC status, thereby diminishing the state's corporate  
            tax base without a commensurate LLC entity-level tax.  In  
            recognition of the expected revenue loss as LLCs replaced  
            corporations as the form of choice for business entities, SB  
            469 contained both an annual tax (in an amount equal to the  
            minimum franchise tax and the limited partnership tax) and an  
            annual fee (based on total income received by the LLC).  In  
            addition to the $800 annual tax, every LLC must pay a fee if  
            the total California annual income is equal to or greater than  
            $250,000.  It was thought that the fee would ensure that  
            allowing LLCs to do business in California had a neutral  
            effect to the state's revenues.  Currently, the LLC fees vary  
            from $900 for income ranging between $250,000 and $499,999 to  
            $11,790 for income of $5 million or more.   

          4)Tax Filing Requirements for LLCs.  All LLCs classified as  
            partnerships or disregarded entities that organize in  
            California, register in California, or conduct business in  
            California, must file California Form 568 Limited Liability  
            Company Return of Income.  California Form 568 must be filed  
            by the 15th day of the 4th month after the close of the LLC's  
            taxable year.  An LLC required to file Form 568 must pay an  
            annual tax of $800 and may be subject to an LLC fee based on  
            its total income derived from, or attributable to, the state  
            of California.  The annual tax is due by the 15th day of the  
            4th month of the taxable year.

            All LLCs classified as corporations that organize in  









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            California, register in California, conduct business in  
            California, or receive California source income, must file  
            California Form 100.  The California Form 100 must be filed by  
            the 15th day of the 3rd month after the close of the LLC's  
            taxable year.  The LLC will be taxed at the corporate tax rate  
            of 8.84% and will be subject to a minimum franchise tax of  
            $800. 

          5)Suspension or Forfeiture and Contract Voidability:  Disparate  
            Treatment for Different Entities?  Under existing law, a  
            domestic LLC as well as a foreign qualified LLC, i.e., an LLC  
            that is registered with the California SOS, may be subject to  
            suspension or forfeiture for failure to file a tax return or  
            for failure to pay delinquent taxes, penalties, fees, or  
            interest within 60 days of the FTB mailing a final notice.   
            Similar rules apply to domestic corporations, foreign  
            qualified corporations, and foreign nonqualified corporations  
            that have an FTB-assigned account number.<1> 

          One of the consequences of suspension or forfeiture for an LLC  
            or a corporation is a possibility that the LLC's or  
            corporation's contracts could be voided.  Any contract entered  
            into by that LLC or corporation may be voided by another party  
            to the contract during the suspension or forfeiture period.   
            The third party may exercise the right to declare a contract  
            void by filing a lawsuit, and a court will not issue a final  
            judgment rescinding the contract unless the taxpayer is  
            provided with a reasonable opportunity to cure the  
            voidability.  In no event may a court order a contract  
            rescinded without providing full restitution to the taxpayer  
            of the benefits provided by the taxpayer under the contract.   
            Existing law allows all business entities subject to contract  
            voidability to obtain relief from contract voidability by  
            filing an application, as prescribed, submitting all  
            delinquent tax returns, and paying any tax as well as  
            interest, fees and penalties due.

          A foreign nonqualified LLC, i.e., an LLC that is not registered  
            with the California SOS, is the only type of business entity  
            that is excluded from the contract voidability provisions.   
            When SB 469 authorized formation of LLCs in California in  
          ---------------------------
          <1> A foreign nonqualified corporation that does not have an  
          FTB-assigned account number is subject to contract voidability  
          on the first day of the taxable year for which the taxpayer has  
          failed to file a required tax return with the FTB.








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            1994, LLCs were specifically included in the definition of  
            "taxpayer" and the FTB was authorized to submit LLCs for  
            suspension to the SOS for non-payment of taxes or for failure  
            to file required tax returns.  This definition applies for  
            purposes of those provisions that relate to suspension,  
            forfeiture and revivor of corporate powers as well as  
            voidability of corporate contracts.  (R&TC, Article 7, Chapter  
            2 of Part 11).  However, the existing definition of "taxpayer"  
            only refers to an LLC, foreign or domestic, that is organized  
            in California or registered with the SOS.  Thus, an LLC that  
            is neither organized nor registered in California with the SOS  
            (i.e., a nonqualified foreign LLC) is not subject to contract  
            voidability.  

          By subjecting those LLCs to the same provisions that currently  
            apply to domestic and qualified foreign LLCs, as well as  
            domestic and foreign corporations, this bill would rectify the  
            inequity of treating similarly-situated taxpayers differently.

          6)The Period of Contract Voidability.  This bill specifies that  
            contracts of an LLC would be subject to contract voidability  
            beginning on the later of:

             a)   The first day of the tax year for which the LLC failed  
               to file a required tax return; or 

             b)   On January 1, 2014.

            According to the FTB, the contract voidability provisions  
            would apply to foreign nonqualified LLCs differently,  
            depending on whether or not the LLC has an FTB-assigned  
            account number.  Similarly to the treatment of foreign  
            nonqualified corporations, a foreign nonqualified LLC with an  
            FTB-assigned account number would be subject to contract  
            voidability if it fails to file a tax return or pay delinquent  
            taxes, penalties, fees or interest within 60 days of the FTB  
            mailing a final notice.  The LLC will be able to obtain relief  
            from contract voidability by either filing an application with  
            the FTB or qualifying with the SOS.   

            A foreign nonqualified LLC without an FTB-assigned account  
            number would be subject to contract voidability beginning on  
            the first day of the tax year for which the LLC failed to file  
            a required tax return (or January 1, 2014, whichever is later)  
            and ending on the date the LLC qualifies with the SOS or  









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            obtains an FTB account number. 
             

          Analysis Prepared by  :    Oksana Jaffe / REV. & TAX. / (916)  
          319-2098 


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