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.

Online Filing Available for LLC Statements of Information

The California Secretary of State has recently updated their process for filing Statements of Information for Limited Liability Companies. Statements of Information can now be filed online using the following link. https://llcbizfile.sos.ca.gov/ The Secretary of State has been processing Statements of Information online for corporations for several years now.

Please note that you will need to have a credit card available to pay the filing fee.

A word of warning from the Secretary of State – all filings and information contained in the filings is public record. Frequently asked questions regarding the public information contained in Statements of Information can be found at http://www.sos.ca.gov/business-programs/pi-faqs/

This is also a good reminder to go online to the Secretary of State’s website http://businesssearch.sos.ca.gov to look at your latest filings. Check that your entity’s last “complete” Statement of Information, (rather than a “no change” filing) has accurate and up-to-date information.

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.

Urgent LLC Alert – Erroneous Tax Refunds

By: Tamara B. Pow, Esq.

Very recently, the Franchise Tax Board (FTB) has had to notify certain California limited liability companies (LLCs) that their 2017 LLC annual tax/estimated fee payment were misapplied to the 2016 tax year, which resulted in the FTB mistakenly sending out refund checks to some LLCs. This issue arose due to a glitch in the software of some tax software companies.

While it is not known how the software glitch occurred, what has been determined is that the software incorrectly applied the Account Period Begin on the 2017 LLC annual tax/fee payment as 01.01.16 instead of the correct begin date, 01.01.17. The Account Period End date was correctly applied as 12.31.17.

In essence, the erroneous refund checks issued by the FTB due to the glitch are based on last year’s estimated income return rather than this year. As a result, LLC payments for this year must be resubmitted by July 15 th , 2017 in order to avoid accruing additional interest and facing penalties. If a refund check has been received, cash the check and then resubmit the payment by the same July 15 deadline . Affected accounts will be reviewed by the FTB after July 15 th and applicable adjustments will be made at that time.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including representing real estate LLCs and other business entities. Her personal experience managing and investing in real estate limited liability companies as well as her MBA and real estate brokers license help her in advising owners of limited liability companies and other business entities.

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.

LLC Tax Reminders

By: Tamara B. Pow, Esq .

As many of you are aware, annual fees for California limited liability companies were due June 15 th . So here are a few pointers to keep in mind as you are filing forms and paying fees. While the due date for filings may have changed this year for some LLCs, the estimated fee due has not.

LLC Fee:

The LLC fee covers income originated from activity within the state of California only, rather than income derived from all applicable markets worldwide. So if an LLC does business worldwide, or even in more than one state in the U.S., only the income earned within the state of California is included in the LLC gross receipts calculation. Even though taxpayers have not reached the midway point to the year, they must still estimate their total 2017 annual income based on the first five and a half months of the year. If there is a remaining balance left as a result of underestimating your total income for the year, that balance must be paid by the next due date for filing an LLC’s tax return (March 15 th for either LLCs taxed as a partnership or single-member LLCs owned by a passthrough entity; April 15 th for all other LLCs).

The estimated fee is required to be at least 100% of the current taxable year fee. If the tax- paying LLC’s estimated fee payment is late or less than the amount owed, the Franchise Tax Board (FTB) will assess an underpayment penalty, which amounts to 10% of the difference between the fee the taxpayer paid and the fee that is owed. Be aware that there is no reasonable cause exception for this penalty. However, there are two other types of exceptions. First, there is a prior-year exception if the timely paid estimated fee is equal to or greater than the fee from the prior year. Second, there is no penalty for an LLCs first-year filing in California, since there is no prior year to begin with.

LLCs Taxed as Corporations:

For LLCs generating annual receipts below $250,000, within the state of California only, the annual fee amount for 2017 is $0. For those generating from 250k up to 500k, the annual fee is $900. For those making from $500k up to $1 million, the annual fee is $2,500. For LLCs earning more than $1 million but less than $5 million, the fee is $6,000. And finally, for LLCs earning $5 million or more per year in the state of California, the 2017 annual fee for LLCs is $11,790.

The next few reminders apply to LLCs that choose to be treated as C corporations or S corporations, who are not required to pay the LLC fee or the annual tax, although C corporations and S corporations are subject to the $800 minimum franchise tax. Furthermore, a single member LLC that has decided not to be taxed as a corporation, but is owned by a C or S corporation, is subject to the annual tax and fee. In this case, the LLC is required to file a Form 568, Limited Liability Company Return of Income, to pay the tax and fee, and will also be subject to the estimated fee requirements.

As for LLCs that are treated as C or S corporations, they must file either Form 100, California Corporation Franchise or Income Tax Return, or Form 100-s, California S Corporation Franchise or Income Tax Return.

Even though the deadline for filing the LLC fee has passed for this year, keep these amounts in mind so that you can make sure you are paying correctly. And if you have not paid your LLC annual fee, make sure you pay it immediately to avoid further penalties and interest.

LLC Alert! Updated LLC Forms

By: Tamara B. Pow, Esq.

The Secretary of State recently updated some of their LLC forms for the second time in several months. They were last updated in July of 2016 and were revised again for 2017.

The forms that have been revised include:

  1. Certificate of Dissolution (LLC-3)
  2. Certificate of Cancellation (LLC 4/7)
  3. Short Form Certificate of Cancellation (LLC 4/8)
  4. Application to Register Foreign LLC (LLC-5)

If you are planning on filing any of the above forms you must use the new forms. Out of date versions will be rejected resulting in additional cost and delays.

No more counterpart signature pages – In the past the Secretary of State has allowed counterpart signature pages for these forms. Effective immediately, counterpart signature pages will no longer be accepted for these forms and any filing submitted with a counterpart signature page will be rejected. All signatures must be on the same piece of paper.

Filing LLC forms with the Secretary of State and getting them back in a timely manner can have a serious impact on your business. Filing a form incorrectly can cause significant delays that can make or break deals. It is important to be familiar with these forms and the Secretary of State’s up to date requirements to prevent delays.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including representing real estate LLCs and other business entities. Her personal experience managing and investing in real estate limited liability companies as well as her MBA and real estate brokers license help her in advising owners of limited liability companies and other business entities.

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.

What Should LLC Managers Get Paid?

By: Tamara B. Pow, Esq.

A question I am frequently asked by LLC owners how LLC managers should get paid? A limited liability company operating agreement should clearly outline payments to both Managers and their affiliates, since these payments are typically made before a determination of whether cash is available for distribution to members.

If you are establishing or investing in a manager managed LLC, the operating agreement should specify how to elect and remove managers , and what powers those managers will have . The agreement should clearly state what fees will be paid to the managers by the company, both for performing their duties as managers and for other transactions between a manager and the company. If a manager will be paid a salary then market rates for those services should be considered, and the terms of employment should be set out in an employment agreement. If the manager will be paid special fees for performing certain duties that are outside of the normal day to day operations, those fees, in addition to the salary, should be approved by the members in advance by inclusion in the company’s operating agreement.

Here are some special fees often seen in real estate LLCs:

Acquisition Fee/Sale Fee: a fee for purchasing or selling an asset, usually based on a percentage of the purchase price of real estate and paid at the closing, often tied to market rates for outside brokers.

Asset Management Fee: an annual fee for managing the invested equity, usually a percentage of funds invested in the company.

Property Management Fee: a fee for acting as property manager, usually a percentage of gross rents, often tied to market rates for outside property management companies.

Construction Management Fee: a fee for managing major construction projects, usually based on the cost of construction.

Development Management Fee: a fee for managing development of a new project, usually based on costs of development.

Financing/Refinancing Fee: a fee for managing a financing of a project, often tied to market rates for third party brokers.

The operating agreement should also have some blanket provisions providing that the company will (or will not) reimburse the managers for their expenses in running the company, and for providing any services that are outside of the scope of a manager’s duties. For example, if a manager also happens to be a lawyer and chooses to draft contracts or represent the company in a litigation matter, the manager should be paid at market rates for those services if they are not an expected part of her duties. If details like this are considered in advance and provided for in the operating agreement, it is less likely a dispute will arise once operations are underway. This is particularly true when monetary payments are at issue.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including representing real estate LLCs and other business entities. Her personal experience managing and investing in real estate limited liability companies as well as her MBA and real estate brokers license help her in advising owners of limited liability companies and other business entities.

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.

Consider Carefully the Powers Granted to LLC Managers!

By: Tamara B. Pow, Esq.

When starting an LLC, carefully consider the powers granted to an LLC manager. Your operating agreement should have customized provisions regarding what the manager(s) can and cannot do – do not just accept some form language. As an LLC attorney, I encourage my clients to carefully consider the powers that their LLC managers should, and should not, have.

Once you have determined whether your limited liability company will be manager managed and you have procedures in place for how you will elect and remove a manager , you need to carefully consider what powers you will give the manager(s) and what limitations you will set on those powers. The business of the LLC is critical to determining what you need to put in your operating agreement. For example, in a real estate investment LLC, make sure the manager has the specific rights to sign deeds and loan documents without going to a vote of the members.

The list of potential powers (and limitations on powers) of the managers is endless, but here are some items to consider:

  • Day to day operations authority
  • Entering into contracts (up to a certain dollar amount?)
  • Opening bank accounts, designating signing authority
  • Paying debts, signing checks
  • Hiring professionals like lawyers and accountants
  • Obtaining insurance at the expense of the company
  • Borrowing funds, refinancing debt
  • Investing company funds
  • Requesting capital from Members
  • Bringing or defending lawsuits
  • Determining cash available for distributions
  • Selling assets of the Company
  • Purchasing major assets
  • Accepting additional Members
  • Approving transfers of membership interests
  • Creating new classes of membership interests
  • Appointing officers, delegating authority
  • Signing tax returns and dealing with tax audits
  • Transacting business with the company, individually or through affiliates
  • Competing with the company’s business or maintaining other employment

If the managers are supposed to be actively participating in the business, rather than simply managing an investment, the LLC agreement should be careful to not only list the powers the manager has, but also the duties and responsibilities that the manager must perform. Make sure you consider the business of your LLC carefully and consider your expectations for the manager position. And once you know what the expectations are for the manager, you need to consider how they should be paid for fulfilling these expectations and include those provisions in your LLC operating agreement as well.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including formations, operations, transfers, conversions and dissolutions of LLCs and other business entities. Her personal experience acting as a manager in real estate limited liability companies as well as her MBA and real estate brokers license help her in advising owners of limited liability companies and other business entities.

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.

Electing and Removing LLC Managers – What You Need to Know

By: Tamara Pow, Esq.

Beware of LLC Managers that can’t be removed! As a business attorney, I work with many LLCs in San Jose and the Bay Area. Some of those have had to remove their LLC manager for one reason or another. I cannot overemphasize the importance of having operating agreement provisions in place to remove and replace a bad Manager.

In a previous blog I discussed the important decision of determining whether you will have a manager managed or a member managed LLC . Once you have decided that your LLC will be manager managed, you should carefully think through the methodologies you want to put in place to elect and remove a manager.

In some LLCs, the manager is another business entity rather than a person, usually either another LLC or a corporation. This is often the structure in real estate development and investment groups where the manager is an entity controlled by the sponsor. If this is the case, election and removal provisions are simple – the manager is stated in the operating agreement and stays as the manager unless a successor is elected by a vote of the members. This vote is usually a supermajority vote, but the percentage will depend on what percent of the company the sponsor insiders own.

However, if the manager is an individual, the LLC operating agreement should consider what happens when the manager resigns, is unable to serve due to a disability or other circumstances, dies, should be removed for cause, or when the members simply want someone else to act as manager. How the operating agreement is drafted for these situations varies greatly based on who is doing the drafting.

If I am representing the manager, I will want to make sure that she cannot easily be removed. In that case, the operating agreement will provide that the manager may only be removed for cause, and such removal requires a vote of a supermajority of the members which supermajority will include the manager’s percentage interest as a member.

If I am representing an investor, I want to make sure the manager can be removed if she is not doing the best job for the company. This could include having a new election every year, or making removal easier (by less than a majority, and not for cause), and replacement easier (by a simple majority of the membership interests).

In a family limited liability company, I will often dictate the initial successor manager in the operating agreement so that if dad is the manager and he dies or is unable to serve for any reason, there is clarity as to who will succeed him – whether that be mom, one of the kids, or an non-family member.

And all of these decisions get even more complicated if your operating agreement will have more than one manager. If you have multiple managers in one LLC, make sure you also consider whether certain groups of investors can elect a manager to represent their interests, or if all managers are elected the same way. And once they are elected, how will multiple managers make decisions? Do they all have to agree? Does a majority in the number of managers rule? These decisions lead to the next topic to consider when forming a manager managed LLC – what will the duties and powers of the manager(s) be? I will discuss powers of LLC managers in my next blog. Don’t assume the answers that are right for you can be found in a form document.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including formations, operations, transfers, conversions and dissolutions of LLCs and other business entities. Her personal experience investing in real estate limited liability companies (both family LLCs and investment LLCs) as well as her MBA and real estate brokers license help her in advising owners of limited liability companies and other business entities.

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.

Should your LLC be Member Managed or Manager Managed? Don’t take this critical decision lightly.

By: Tamara Pow, Esq.

One of the first decisions you have to make when you decide to form a limited liability company is whether the company will be managed by the members or by one or more managers. This decision is so important, it is one of the very few items of information the California Secretary of State requires on the Articles of Organization – the basic document that is filed in order to create your LLC. The Articles require that you state if the LLC will be managed by one manager, more than one manager, or by all of the LLC members.

Unless the Articles say the company is manager managed, the business of the LLC will be managed by all of the members. So, unless the Articles of Organization or the Operating Agreement specifically state that the company is manager managed, every member is an agent of the company and may act on its behalf, and such act will bind the LLC unless the member has no such authority and the person that member is dealing with has actual knowledge that the member has no authority. In other words, unless you want each member to be able to bind the company in its business or affairs, you should mark one of the boxes for manager managed on your Articles of Organization and specifically include manager authority provisions in your LLC’s operating agreement.

I recommend you always clearly call the managers of the company “Managers” whether or not they are also members. I dislike the term “Managing Member” because it is unclear without reading the operating agreement of the company whether a Managing Member is just one of many members in a member managed limited liability company, or whether the Managing Member is a Manager that also happens to be a member (but possibly has more authority than other members if they are not also managers). “Manager” and “Member” are much clearer terms that provide more information to third parties dealing with the LLC.

Once you have decided whether your LLC will be manager managed or member managed, you need to take it a step further and decide how many managers you want and how they will make decisions. You could choose to appoint or elect a number of managers to be on a board of managers, like the board of directors of a corporation. Or, you could choose one person to be the sole manager. Then you can think about whether the Managers, or their appointees, should have authority over different areas of management like officers in a corporation. You can even name Managers, or others, to officer positions in the company’s operating agreement.

Now that you have decided that your LLC will be manager managed, and how many managers you will have, there are many other considerations that should be thought out and included in your operating agreement, including methodologies to elect and remove managers, powers of managers (and limitations on those powers), deadlock provisions if you have an even number of managers, fees paid to managers by the company, and other transactions between a manager and the company.

Tamara B. Pow is a founding partner of Strategy Law, LLP in downtown San Jose, California where she practices business and real estate law including formations, operations, transfers, conversions and dissolutions of LLCs and other business entities. Her personal experience investing in real estate limited liability companies as well as her MBA and real estate brokers license help her in advising owners of limited liability companies and other business entities.

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.