BILL ANALYSIS Ó AB 1143 Page A CONCURRENCE IN SENATE AMENDMENTS AB 1143 (Skinner) As Amended June 9, 2014 2/3 vote. Urgency ----------------------------------------------------------------- |ASSEMBLY: |73-0 |(May 13, 2013) |SENATE: |36-0 |(August 4, | | | | | | |2014) | ----------------------------------------------------------------- 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 AB 1143 Page B 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. AB 1143 Page C 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 AB 1143 Page D 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 AB 1143 Page E 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. AB 1143 Page F 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 AB 1143 Page G obtains an FTB account number. Analysis Prepared by : Oksana Jaffe / REV. & TAX. / (916) 319-2098 FN: 0003931