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.