A Last-Minute Word to the Wise for Soon-to-be Corporations and LLCs in CA

As we get closer to the end of the year, there are a couple of extremely important tax-related items to remember for anyone who may be getting close to starting a corporation or LLC, preparing to file their Articles of Incorporation, looking to expand their operations into California, or just may be thinking of doing so. The items I am referring to are the $800 minimum tax and the 15-day end of the year tax exemption. But first, with the holiday season now in full swing, let’s start off with a quick tale.

Once upon a time, there was a company called C&L Pacific, a newly formed S Corporation that had four shareholders and intended to do business in California. On December 12 th , 2011, C&L Pacific mailed its Articles of Incorporation to the office of the Secretary of State of California, with the intent of becoming “incorporated.” Their Articles were officially marked “filed” two days later, on December 14 th . However, they were not processed until March 24 th , 2012, and C&L Pacific subsequently did not learn about the Articles of Incorporation being processed until April 2012, after which the company then proceeded to conduct business operations.

Based on those facts, C&L Pacific assumed it did not have to file a tax return for 2011 or pay the minimum corporation tax of $800 for that year. However, it was mistaken. Outlined in the ruling from C&L Pacific’s appeal before the Franchise Tax Board (FTB), California’s Revenue and Tax Code (R & TC) §23153 states that “[A] corporation becomes liable for the $800 minimum tax when it incorporates in California, qualifies to do business in California, or if it is actually doing business in California.” So, when does a corporation’s existence, or “incorporation,” begin? Even though C&L Pacific did not start doing business in California until 2012 and the Articles of Incorporation were not processed until 2012, California’s Corporations Code § 200 says, “[a] corporation ‘incorporates’ in California on the date that its articles are filed with the Secretary of State,” meaning that C&L Pacific was incorporated on December 14 th , 2011 when the Articles were marked filed, rather than in March 2012 when they were processed.

As for whether the taxpayer was required to file a tax return for the 2011 tax year, if C&L Pacific had waited just a day longer to mail their articles, they would have qualified for the 15- day end of the year tax exemption, which would have excused the taxpayer from being required to file a return. “A corporation is not subject to the minimum franchise tax (and is not required to file a return) if it did not do business in California during the taxable year, and the taxable year was 15 days or fewer” (R & TC §23114).

So not only would the taxpayer have avoided needing to file a return, they also would have not been required to pay the $800 minimum tax for the 2012 tax year since C&L Pacific would have qualified under the “First-year-free” tax exemption rule, under R & TC §23153(f). The FTB did not assess the minimum franchise tax for 2011 because C&L Pacific qualified for the first-year-free exemption but this exemption was lost for 2012. The taxpayer was assessed a $432 per-shareholder penalty by the FTB, and ordered to file a tax return for the 2011 tax year, because the Board deemed the “taxpayer’s failure to distinguish between the importance of the filing date and processing date” to not be reasonable cause for failing to file.

As soon as a corporation or LLC files Articles with the Secretary of State of California, the taxpayer is formed in the state of California. So if you won’t be doing business until the new year, make sure you don’t file before the last two weeks of the current year. And as a side note – this all could have been avoided if C&L Pacific hadn’t mailed in its Articles for filing. We file documents over the counter in Sacramento to skip the months long wait for mailed filings and for clear tracking of filing dates.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

Reverse Veil Piercing: Another Reason to Pay Your Bills

By: Tamara B. Pow, Esq .

A recent California Court of Appeals case ( Curci Investments, LLC v. Baldwin ) means California LLC assets could be at risk for a member’s personal liability. Baldwin borrowed $5.5 million from an investment firm, as a predecessor to Curci Investments Inc. (“Curci”). Fast forward three years to the due date and Baldwin does not repay his debt. Curci files a lawsuit to collect the debt, but agrees to stipulate to an extension to allow Baldwin to pay his debt over time. At the end of that extension in 2012, Baldwin still does not pay back the investment firm, so the trial court in California files an Entry of Judgment against Baldwin for $7.2 million, including prejudgment interest and attorney fees and costs. In 2014, Curci files a motion seeking charging orders against some of the business entities that Baldwin may have invested in or been involved in some way. The court grants this motion for 36 entities which then made no distributions. The court then rules against Curci when Curci tries to access Baldwin’s assets through Baldwin’s LLC, in what is known as “reverse veil piercing.” The court was concerned with the possibility of harming innocent shareholders and corporate creditors, allowing judgment creditors to bypass standard judgment collection procedures, and using an equitable remedy when legal remedies are available. Most of all, however, the court ruled against Curci because it believed that reverse veil piercing was not available in California.

Here is the interesting part. Baldwin had previously formed and held interests in hundreds of corporations, partnerships, and LLCs, 36 of which were included in Curci’s motion seeking charging orders. The business in question is JPBI LLC, a Delaware LLC used for the exclusive purpose of holding and investing Baldwin and his wife’s cash balances. From 2006 to 2012, JPBI distributed roughly $178 million to Baldwin and his wife, (during which time Baldwin borrowed money, agreed to the stipulation to extend the date to pay the investment firm and was ordered by the court to repay Curci). To top it all off, Baldwin owned 99% of JPBI LLC, while his wife owned the remaining 1%.

All of that would mean nothing, however, without the applicability of reverse veil piercing, the inverse of traditional veil piercing. The trial court thought it to be unavailable in California, based on the decision of another case, Postal Instant Press, Inc. v. Kaswa Corp. (2008), which ruled that the veil of a corporation could not be pierced under certain conditions. However, in the timely appeal filed by the plaintiff, the California Appeals Court was able to differentiate that case from this one, ultimately remanding the case back to the trial court, with instructions to determine whether JPBI’s veil should be pierced. While the Appellate Court did not rule whether JPBI’s veil should be pierced, it did make clear that reverse veil piercing, which is the act of a collector satisfying the debt of an individual through the assets of an entity of which the individual is an insider, is available in California for several reasons:

First, the facts of this case allay any concerns the trial court had based on the previous case. Since Baldwin and his wife owned the entire company, and were in charge of when JPBI distributed money, there were no innocent shareholders involved. Additionally, Curci explored all avenues, and pursued other legal remedies, before filing the motion seeking charging orders. This satisfied the court’s concern that creditors bypass standard judgment collection procedures or other legal remedies.

Second, the previous case applied only to corporations, whereas JPBI is an LLC. Per the trial court, in reading the decision from the previous case, “A third party may not pierce the corporate veil to reach corporate assets to satisfy a shareholder’s personal liability.”

Third, Corporations Code § 17705.03, which Baldwin had used to argue his case, was read by the Appellate Court as the exclusive remedy for reaching the judgment debtor’s “transferrable assets,” not referring to his LLC’s assets.

Fourth, the Revised Uniform Limited Liability Company Act, from which the previous statute came from, included comments that the charging provisions “were not intended to prevent a court from effecting reverse veil piercing where appropriate.”

Next the trial court will have to determine whether Curci can in fact pierce JPBI LLC’s veil to use Baldwin’s assets to satisfy his debt. The court will have to determine this by evaluating the same factors that are applied in a traditional veil piercing case, as well as whether Curci has any plain, speedy, and adequate remedy at law.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.