BILL ANALYSIS
SENATE REVENUE & TAXATION COMMITTEE
Senator Lois Wolk, Chair
AB 2458 - Saldana
Amended: May 3, 2010
Hearing: June 23, 2010 Fiscal: yes
SUMMARY: Extends Due Date of Underpayment Penalty on
Annual Limited Liability Company (LLC) Fee for a
Small Business
EXISTING LAW, the California Limited Liability Company
Act, allows limited liability companies (LLCs) to engage in
lawful business activities in the state subject to
specified restrictions and requirements (SB 439, Beverly,
1994). LLCs provide liability protections to its members
similar to those provided to a corporation's shareholders.
LLCs are treated as partnerships, not corporations, for
federal tax purposes, where the LLC as an entity is not
taxed but LLC members pay tax on the distributive share of
income at the member's marginal rate. While a member is
subject to California Personal Income Tax on the
distributive share of the LLC's income, California taxes
LLCs as an entity differently:
California LLCs must file tax returns
and pay an $800 annual LLC tax.
In addition to the LLC tax, California
LLCs must also pay an LLC fee between $900 and
$11,790 based on its total income from all
sources derived or attributable to this state
according to the table below:
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If total income from all sources reportable to the state
is:
Equal to or Over ($) But not Over ($)
LLC Fee ($)
-----------------------------------------------------------
| 250,000 | 499,999 | 900 |
| | | |
|-------------------+-------------------+-------------------|
| 500,000 | 999,999 | 2,500 |
| | | |
|-------------------+-------------------+-------------------|
| 1,000,000 | 4,999,999 | 6,000 |
| | | |
|-------------------+-------------------+-------------------|
| 5,000,000 | and over | 11,790 |
| | | |
-----------------------------------------------------------
EXISTING LAW requires, for taxable years beginning on
or after January 1, 2009, the LLC to estimate the fee it
will owe for the taxable year and make an estimated fee
payment by the 15th day of the 6th month of the taxable
year. The LLC fee remains due and payable by the due date,
without extension, of the LLC's return. If the taxable year
of the LLC ends prior to the 15th day of the 6th month of
the taxable year, no estimated fee payment is due and the
LLC fee is due on the due date of the LLC's return.
A penalty applies if the LLC's estimated fee payment is
less than the fee owed for the taxable year. The penalty is
equal to 10% of the amount of the LLC fee owed for the year
over the amount of the timely estimated fee payment.
However, the underpayment penalty is not imposed when the
estimated fee payment is equal to or greater than the LLC's
prior year fee liability.
THIS BILL would allow a small business to pay the 10%
underpayment penalty on its annual LLC fee 60 days from the
date the small business is notified of the penalty by the
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Franchise Tax Board (FTB). The bill defines a "small
business" as a business whose total income from all sources
derived from or attributable to this state for the taxable
year is one million dollars ($1,000,000) or less.
THIS BILL requires this provision to be applied to
penalties imposed on or after January 1, 2011 and before
January 1, 2016.
FISCAL EFFECT: FTB staff estimates costs of approximately
$40,000 to develop, program, and test revisions to existing
systems for changes needed to implement this bill; they
have requested an appropriation. Additionally, FTB staff
estimates a revenue loss of less than $150,000 in 2009-10,
a $6,000 loss in 2010-11, and a $3,000 loss in 2011-12 due
to the delayed timing of the payment.
COMMENTS:
A. Purpose of the Bill
The author states, "California is unique in that a
majority of the businesses in the state are small
businesses. Due to the depressed economy, many small
businesses are experiencing financial hardships. Although
it is reasonable for companies to pay the basic costs for
operating in the state, they often struggle to pay these
costs due to revenue problems. As a result, they are
charged penalties and interest.
LLCs pay an annual tax up to $11,790 based on the total
taxable income generated to the FTB. An additional charge of
10% on the underpayment is due once the tax is delinquent.
As these fees accumulate during these difficult economic
times, they make it harder for smaller companies to stay in
business.
The ripple effect from losing these businesses further
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dampens the state's fiscal condition. If these companies go
out of business, the state loses revenue from employment and
personal income taxes. Additionally, the state likely pays
for services, such as health coverage and unemployment,
needed by the former employees.
AB 2458 would extend the due date for late penalty
payments to 60 days for small businesses. This allows
struggling companies to get some relief to continue to
operate. In turn, Californians stay employed, and the state
benefits from the revenues of these businesses."
B. Background on LLC Fee
As part of the initial legislation authorizing LLCs in
California, the Legislature enacted the LLC fee fearing
that the federal tax benefits conferred by LLC status would
lead many businesses to change to the LLC form and 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. The Legislature
intended that the fee would ensure that allowing LLCs to do
business in California had a neutral effect to the state's
revenues. Initially, the Legislature set the fee based on
an LLC's income, with five levels, and the amount of tax
was capped at $4,000 in 1994 and 1995, and $4,500 in 1996.
The Legislature allowed the FTB to study and revise LLC fee
amounts to ensure state revenue neutrality (SB 715,
Committee on Revenue and Taxation, 1996), resulting in
higher fee amounts in 1999 and 2000, then repealed the
FTB's fee adjustment authority and instituted the current
fee amounts (AB 898, Leach, 2001).
Until recently, the LLC fee statute contained a fatal
flaw; the law as applied by the FTB required taxpayers to
include income earned in other states when calculating
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their California LLC fee. In 2006, two superior court
decisions, Northwest Energy Services v. Franchise Tax Board
(Case No. CGC-05-437721) and Ventas Finance I, LLC v.
Franchise Tax Board (Case No. CGC-05-440001) held that the
LLC statute violated United States Constitutional
safeguards precluding states from taxing income derived
outside its boundaries (Northwest was subsequently upheld
on appeal). In response, the Legislature approved AB 1614
(Ruskin) seeking to remedy the LLC fee's constitutional
deficiencies by specifying that LLCs are taxed only on
California income. That measure applied to taxable years
beginning in 2001, thereby ensuring that the state would
not refund the approximately $1.5 billion in LLC fees paid
to the state between 2001 and 2005 if an appellate court
nullified the statute. Governor Arnold Schwarzenegger
vetoed the measure, stating that legislative action was
premature due to ongoing litigation. However, in 2007, the
Legislature approved, and the Governor signed AB 198
(Committee on Budget), which required taxpayers to include
only income derived in California when calculating the LLC
fee, thereby correcting the flaw. That measure further
limited refunds solely to the amount unconstitutionally
collected, not the total amount of the tax paid.
C. Underpayment Penalty
In 2008, AB 1452 (Committee on Budget) was enacted to
conform the treatment of LLCs to local business license
taxes and personal income taxes, which require estimated
payment in the tax year, instead of the following year. AB
1452 also imposed an additional penalty for underpayment.
Prior to 2009, the FTB was allowed to assess the
underpayment penalty of 5% on the underpaid balance and the
late filing penalty of .05% on the underpaid balance per
month as applied to personal income taxpayers.
Generally, strict, enforceable penalties lead to
higher compliance rates; taxpayers have little incentive to
report income accurately unless the tax agency can detect
evasion and levy penalties. LLC fees are not significant
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when compared to other tax liabilities and the simplicity
of calculating the fee, which amounts to consulting a
table, should not likely lead to taxpayer errors. However,
the 10% penalty is relatively high when compared to other
understatement penalties.
D. Is the Benefit Worth the Trouble?
There are approximately 263,000 LLCs in the state. The
FTB estimates 5% of these pay the underpayment penalty. Of
this amount, the FTB estimates 20%, or approximately 2,630
LLCs (1% of all LLCs in the state), would fall under the
definition of a small business as set forth in this bill.
Currently, if an LLC does not pay its estimated fee payment
or underpayment penalty when due, interest is computed from
the due date of the return at a rate of 4% per year on each
amount due. Under this bill, interest would not accrue on
the underpayment penalty assessed a small business until 60
days from the date the business is notified of the penalty
by the FTB.
The maximum penalty for a small business, as defined in
this bill, would be $250 (10% x $2500). This assumes the
LLC made no estimated fee payment for the current year, the
prior year's estimated payment fee was $2500, and the LLC
had income of $500,000 to $999,999 for the year.
Alternatively, the underpayment penalty could be $90 ($900 x
10%) or $160 ($2500 less $900 payment made x 10%). Annual
interest, at a rate of 4% on $250, is $10. Delaying the
penalty seems to hardly be worth the cost: Does an average
cost of less than $200 per entity help more California LLCs
stay in business? Will postponing a payment of $250 or less
give a struggling company a make-or-break benefit?
E. What's a Small Business?
AB 2458's definition of a small business applies to
LLCs making between $500,000 and $1,000,000 be defined as a
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small business. While defining a small business is in the
eye of the beholder, and both federal and state tax law uses
several different measurements, is a firm with more than
one-half of one million dollars small enough to enjoy the
benefit granted by AB 2458? The Committee may wish to
consider amending AB 2458 to mean a business with total
income from all sources derived from or attributable to this
state for the taxable year is less than five-hundred
thousand dollars ($500,000). In its current form, the bill
costs the state upwards of $150,000 in the first year of
implementation due to the timing of receipt of the
underpayment penalty. By making these amendments, the
estimated revenue cost to the state is reduced to $20,000 in
the first year of implementation and focus of the bill on
smaller California LLCs.
Support and Opposition
Support:California Taxpayers' Association
Oppose: None
---------------------------------
Consultant: Mary Beth Faulkner
AB 2458 - Saldana
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