Tax collectors may come after a small business that is sold but not officially closed. But there are ways to fight back
Dear Your Business Credit,
I am planning to open another business in California. It is not a restaurant, but I want to be sure, in the future, I will not have a problem and that they would not go after my accounts and get penalties, etc. Can you give me advice? — Lala
Yikes! What a headache!
The Franchise Tax Board – the California department that collects state personal income taxes as well as bank and corporation taxes owed to the state — could keep pursuing you for the penalties, but fortunately, there are some steps you can take that may help, according to Michael Raanan, an enrolled agent at Landmark Tax Group in Santa Ana, California. His firm has worked with a number of clients who were issued the same status by the Franchise Tax Board.
“We see this a lot,” says Raanan. “It’s very common that taxpayers in California operate a business and then for one reason or another end up abandoning the entity, and the business ends up not filing formal tax returns. Nor do they formally dissolve the entity with the Secretary of State. The Franchise Tax Board starts sending out letters to the business saying certain taxes have to be filed and are now past due. This goes on for many years, and the state ends up suspending the license of the business.”
Generally, the owners who have come to Raanan have set their businesses up as corporations. When their license is suspended, Raanan says, the state of California usually files a tax lien in the name of the business, which lets other creditors know the state has priority on any income or assets of the business. The state will then start issuing levies to any income sources of the business, such as bank accounts, he says. “After they end up exhausting collection efforts on the corporation, the Franchise Tax Board starts looking at collections on the shareholder.”
Fortunately, there is something you can do to turn a situation like this around, but I would strongly recommend that you do so with the help of a California attorney or accountant experienced in working with the Franchise Tax Board.
Raanan says some companies have invoked what is known as the Ralite Decision when they failed to dissolve a corporation and the Franchise Tax Board attempted to collect from them. That court decision says a shareholder cannot be liable for the taxes of a business entity if certain conditions have been met. For instance, one condition is that any assets of the business were categorized at fair market value and were properly liquidated, he says. Another condition is that no assets or income were taken from the business by the shareholder without adequate compensation to the business account.
Raanan says he knows of no similar court decisions with regard to LLCs. However, many of his clients who set up LLCs have been able to successfully invoke the Ralite Decision as well, he says.
Invoking the Ralite Decision is not your only alternative: You can alternatively have the corporation file the final tax returns that are missing and formally dissolve the entity with the Secretary of State so there are no open-ended issues with that corporation. “Now the shareholder can freely open as many entities as they want without worrying,” Raanan says.
Your situation is a good reminder of how important it is to close a business properly. “Until a business is officially dissolved by the filing of a certificate of dissolution with the state, it continues to be an `active’ business — even if the business is no longer operating,” Jennifer Friedman, vice president of Wolters Kluwer’s CT Corporation, which offers services that assist companies in staying in good legal standing. No one wants to file paperwork for a business that has closed but it can save a lot of hassles in the long run.
See related: Can I borrow to pay my business tax bill?, Long after business is sold, old card debt arises, Big debt from business failure? Try talking to creditors