Do I really have to pay the State of California Annual Minimum Franchise Tax?
They say two things in life are a certainty ...death and taxes. A small company named Swart Enterprises, Inc. ("Swart") found out the hard way how states are always trying to get more revenue via tax dollars. If you haven't heard about Swart, don't feel too bad. It is a small, family owned company incorporated in Iowa. It operates a 60-acre farm in Kansas where it occasionally feeds cattle for beef sales in Nebraska. Its headquarters and primary place of business are located in Iowa. Swart does not have a physical presence, real or personal property, or any employees in the State of California. They are not registered with the California Secretary of State in order to transact interstate business. It must have been a big surprise when Swart was contacted by the California Franchise Tax Board demanding Swart to file a California corporate franchise tax return for the tax year ending June 30, 2010. The minimum franchise tax due in California is $800.00. Once the penalties and interest were added in, Swart had to pay $1,106.00. Swart contested the demand and requested a refund.
Why did the California Franchise Tax Board demand Swart pay the tax? In 2007, Swart invested in Cypress Equipment Fund XII, LLC ("Cypress"), becoming a member of the LLC. This investment amounted to a 0.2 percent (0.2%) ownership interest. Cypress is a manager-managed LLC, not a member-managed LLC. Basically, in a manager-managed LLC, the members hire a manager to conduct the day to day business, as opposed to the members of the LLC conducting the day to day business. California's franchise tax is imposed on every corporation that is "doing business" within California, whether or not it is incorporated, organized, qualified, or registered
under California law. (Rev. & Tax. Code,1 § 23151, subd. (a).) The phrase "doing business," for purposes of the franchise tax, means "actively engaging in any transaction for the purpose of financial or pecuniary gain or profit." (§ 23101, subd. (a); see Cal. Code Regs., tit. 18, § 23101 (Regulation 23101).)
Swart timely filed a complaint seeking a tax refund and declaratory relief. Swart argued that its 0.2% ownership as a passive (limited) member is not enough to prove Swart is "doing business" within California. In addition, Swart argued it was not a founding member of Cypress and had no voting rights or influence during the founding of Cypress. Therefore, they have always been a passive member of Cypress. Since it is a manager-managed LLC, Swart does not influence the day to day operations. Even if Swart was not passive, a 0.2% share is not enough to influence the other members of the LLC. Both Swart and the California Franchise Tax Board entered motions for summary judgments. The trial court entered an order granting Swart's motion for summary judgment. Swart was awarded a refund in the amount of $1,106.71. On November 25, 2014, the notice of entry of judgment was served. On January 16, 2015, the Franchise Tax Board filed a timely notice of appeal.
The appellate court also ruled in favor of Swart. They found: "[w]e conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC. The Attorney General's conclusion that a taxation election could transmute Swart into a general partner for purposes of the franchise tax, and that the business activities of Cypress can therefore be imputed to Swart, is not supported by citation to appropriate legal authority and, in our view, defies a commonsense understanding of what it means to be 'doing business.'"
This article only gives the highlights of the case. It does not go into many of the details. If you feel like you are also having to pay a tax that you have no duty pay, you may want to research this some more. At least for this very specific case, "taxes" did not win.
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Case of the Month
Wind Dancer Production Group et al. v. Walt Disney Pictures et al.
Many people remember the television series Home Improvement. It was a popular television series that aired on network television between 1991 and 1999. What people may not know about the show, is Wind Danger Productions Group (the "Producers") and Walt Disney Pictures ("Disney") have had an ongoing disagreement which has recently been ruled upon by a court of appeal.
The basis of the disagreement stems from a series of written agreements, which collectively are referred to as the "profit participation agreement". In this agreement, the Producers agreed to transfer rights to the series over to Disney in exchange for 75% of all net profits earned by the series. During the negotiations, the Producers were represented by highly regarded agents, attorneys, and production companies. Part of this agreement was that the Producers would have audit rights to check the financial statements Disney sent to them. The Producers also had a 24 month period in which to object to the statements and then a 6 month period after that in order to bring any legal action if they deemed it necessary. Since the show began, the Producers have requested a total of six (6) audits. This particular lawsuit involves only Audit 4 and Audit 5.
Audit 1 covered the time period from when the show started until March 31, 1996. Many of the objections the Producers raised were more than 30 months old, and they filed a lawsuit. The parties settled the lawsuit in April 1999. Disney did not assert any rights to the limitation period in the lawsuit for Audit 1.
Audit 2 covered the time period from April 1, 1996 through December 31, 1998. Audit 3 covered the time period from January 1, 1999 through December 31, 2000. The auditors hired by the Producers issued the Audit 2 report in December 1999 and the Audit 3 report in May 2002. In August 2002, the Producers and Disney began negotiating the resolution of the claims the Producers raised for Audits 2 and 3. Again, many of the objections raised by the Producers were well over 24 months old. Disney never asserted any rights to the limitation period. Six years later, in May 2008, both parties settled the claims raised by Audit 2 and Audit 3 without proceeding to litigation.
On November 18, 2003, the Producers orally notified Disney they intended to conduct Audit 4 for the period of January 1, 2001 to December 31, 2003. On February 17, 2006, the Producers provided a written notice they intended to conduct Audit 5 for the period from January 1, 2004 through December 31, 2005. On July 29, 2008, the Producers sent their Audit 4 and Audit 5 report to Disney with their objections. On August 13, 2008, Disney's new in-house attorney responded the Audit 4 and Audit 5 objections are more than 24 months old and are issued too late. Keep in mind, this is only a few months after Disney and the Auditors settled the claims for Audit 2 and Audit 3 without going to litigation. This is the first time in the parties' relationship that Disney asserted the Producers' audit claims were time-barred.
On March 17, 2009, the Producers provided Disney written notice they intend to audit the period from January 1, 2006 through the date that the audit commenced (Audit 6). Disney informed the Producers that there was a waiting period before a new audit could commence and the Producers had to wait their turn in the audit queue. On June 18, 2013, Disney informed the Producers the audit could begin for the period ending December 31, 2012. This was more than four years after the initial audit request. On November 7, 2013, the Producers provided Disney with written objections to "each and every line item and category set forth in the Audit 6 statements". This was done to preserve the Producers' potential object claims under the 24 month period. Disney rejected the claim because many items for Audit 6 were already over 24 months old and the objections lacked specific data for why they object. Part of the contract was the objections needed to contain the specific item they are objecting to. It didn't matter that Disney had not supplied the Producers any specific data on the line items in a sufficient time frame.
The parties were not able to reach a settlement on Audit 4 and Audit 5. On February 27, 2013, the Producers filed action against Disney. On February 4, 2014, Disney filed a motion for summary adjudication because the claims were more than 24 months after the due date and more than 6 months after that to file any legal action. After many legal arguments, filings, and proceedings, the trial court granted Disney's motion on January 6, 2015. Of course, the Producers appealed the ruling.
The appeals court reversed the trial court's judgment. The main factors in the reversal are because Disney issued summary statements and not detailed statements for the Producers to audit. When the Producers requested the detailed information, it took many years in most cases to actually get the data in order to conduct the audit. The 24 month window was not a long enough time frame to conduct such a detailed audit. When the Producers produced objections on Audit 6 without the detailed information, Disney claimed it lacked detail and therefore merit. The lack of claiming the 24 month window limits for Audits 1-3 was also a factor. It set up an expected course of action that lead the Producers into thinking the same actions would occur for Audits 4-6. Therefore, the Appeals Court concluded that there are triable issues of material fact. The trial court accordingly erred in granting summary adjudication in favor of Disney. The Producers shall recover their costs on appeal.
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The Internal Revenue Service (IRS) revised the 1099-S form for 2017. One needs to file Form 1099-S, Proceeds From Real Estate Transactions, to report the sale or exchange of real estate. The new form went into effect on January 1, 2017.
The change is a new checkbox has been added as box 5. The checkbox is to report if the transfer of real estate is conducted by a foreign person. The previous box 5, Buyer's Part of Real Estate Tax, in now box 6.
The penalty for filing an incorrect form is $250 per filing. It is capped at $3 million per calendar year. It is possible to have the penalties reduced if the correct 1099-S is filed before certain dates. If you are creating or filing any 1099-S forms for 2017, ensure you have the new revision in order to avoid any possible penalties.
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Upcoming Speaking Engagements
For April 2017, Jennifer has the following speaking engagements:
Tri-County Escrow Association, Tuesday, April 11, 2017
Ojai Valley Board of Realtors, Wednesday, April 12, 2017
The Inland Gateway Association of Realtors, Tuesday, April, 18, 2017
Conejo Simi Moorpark Association of Realtors, Friday, April 21, 2017
Escrow Training Institute, Saturday, April 29, 2017
For details about one or more of these events feel free to contact our office.
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