We represent clients from all U.S. and International locations regarding Federal Tax and California Issues.
In Ralite, the corporation had approximately $106,000 in cash. The two shareholders took the cash as a pay out in the form of a dividend and abandoned the corporation without having paying the franchise tax. The shareholders failed to formally dissolve the corporation with the Secretary of State and the Franchise Tax Board (FTB) subsequently sued for the tax owed.
On appeal the FTB conceded that no law existed to pierce the corporate veil and hold the shareholders personally liable since neither had expressly assumed the liability. Therefore, any recovery for the back taxes would have to be based in equity for fraudulent conveyance. Consequently the FTB had to prove all of the following before the shareholders could be held liable for the corporation’s franchise tax:
In the case of Ralite, all the conditions were met, therefore the shareholders were liable for the corporation’s franchise tax.
Using the Ralite decision as a guide, be mindful of the following events. First, the shareholder(s) abandon the corporation and fail to formally dissolve the entity with the Secretary of State within 12 months of filing the final return with the FTB. Second, the FTB sends the corporation a Demand to File notice. Third, the FTB begins billing the corporation, which no longer has any assets for the FTB to collect form. Fourth, the FTB comes to the shareholder and demands payment. Here is when to invoke theRalite decision, explaining that the taxpayer did not take compensation that was not owed. In response enclose
Upon showing that the shareholder did not receive any more than was owed the FTB will generally close the account.
One major pitfall to avoid is the business that is still in business. Sole proprietors may be held liable as transferees for delinquent corporate taxes unpaid before a change or transfer. Thus, it is important to draw a distinction between abandonment of a corporation versus continuing the business as a sole proprietor. Corporate property taken by the shareholder to use in a business includes but is not limited to: notes and accounts receivable, inventories, real and personal property, goodwill, and client lists.
It is possible to apply Ralite to walking away from a limited liability company (LLC) because a LLC has limited liability like a corporation. However, Ralite does not apply to a limited partnership (LP) because the general partner of an LP is always liable for the debts of the LP.