California Franchise Tax

Generally

Each year, all corporations doing business in California, including:

• S-Corporations;
• LLCs, apart from certain title-holding companies (CA RTC §§23701h and 23701x); and
• Limited Liability Partnerships (“LLPs”)

Must pay a corporate franchise tax each year:

• Including any calendar year of twelve (12) months or less (RTC §23102);
• Measured from the date of their incorporation or doing business until their effective date of dissolution or withdrawal).

General Corporation Franchise Tax

Corporations (and LLCs electing to be classified and taxed like corporations) must pay a franchise tax due equal to the greater of:

• The Minimum Franchise Tax of Eight-Hundred Dollars ($800) (RTC §23151(d)); or
• Eight-point-eight-four percent (8.84%) of the net income for that taxable year.

Note: Many such corporations are also liable for a 6.65% alternative minimum tax

Franchise Tax for Pass-Through Taxation Entities

S Corporations doing business in California must pay a franchise tax due equal to:

• The Minimum Franchise Tax of Eight-Hundred Dollars ($800) (RTC §23151(d)); and
• One-point-five percent (1.5%) of the S Corporation’s net income for that taxable year.

LLCs (electing to be classified and taxed like partnerships rather than corporations) must pay a franchise tax due equal to:

• The Minimum Franchise Tax of Eight-Hundred Dollars ($800) (RTC §23151(d)); and
• If the LLC earns income of at least two-hundred-fifty-thousand dollars ($250,000):
• If the income is from $250,000 to $499,999, an additional $900 is due;
• If the income is from $500,000 to $999,999, an additional $2,500 is due;
• If the income is from $1,000,000 to $4,999,999 $6,000 is due; or
• If the income is $5,000,000 or more, an additional $11,790 is due.

LLPs must pay an annual franchise tax of eight-hundred dollars ($800).

"Doing Business In California"

Doing business is defined as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit” and applies to any taxpayer:

• Organized or commercially domiciled in California;
• With sales (including sales by taxpayer’s agent or independent contractor) that exceed the lesser of:
• Five hundred thousand dollars ($500,000); or
• Twenty-five percent (25%) of the taxpayer’s total sales.
• That owns real property and tangible personal property of the taxpayer in California that exceeds the lesser of:
• Fifty thousand dollars ($50,000); or
• Twenty-five percent (25%) of the taxpayer’s total real property and tangible personal property.
• Receiving compensation in California that exceeds the lesser of:
• Fifty thousand dollars ($50,000); or
• Twenty-five percent (25%) of the total compensation paid by the taxpayer.

Corporations not deemed to be doing business in California include:

• Any corporation engaged only in holding stock or bonds of any other corporation(s) and receiving dividends (RTC §23102).
• Any corporation not incorporated in California and working in California:
• Only at conventions and trade shows;
• For seven or fewer calendar days in a taxable year; and
• Receiving no more than ten thousand dollars ($10,000) of gross income for that work.
• Corporations so determined by the Franchise Tax Board when the corporation’s only activities are either:
  • The purchase of personal property or services solely for use by the corporation or its affiliate outside this state if the corporation has no more than 200 California in-state employees total, with:
  • No more than 100 in-state employees engaged only in solicitation, negotiation, liaison, monitoring, auditing, and inspecting the personal property or services acquired, or providing technical advice with respect to its requirements; and
  • No more than 200 employees in-state employees engaged only in solicitation, negotiation, liaison, monitoring, auditing, and inspecting the personal property or services acquired, or providing technical advice with respect to its requirements, and the personal property or services purchased by the corporation or its affiliate are used for the construction or modification of a physical plant or facility located outside California; or
• A corporation whose employees are in California only to attend a public or private school, college, or university; or
• A corporation (or LLC) that did no business in California during a tax year of fifteen (15) days or less. (RTC §23114).

A corporation can petition the Franchise Tax Board (“FTB”) for a determination that the corporation’s activities do not constitute “doing business in California.”

• Such petitions waive the Corporate confidentiality with respect to facts in the petition are waived.
• If the petition is granted, the FTB’s determination:
  1. Is valid for five years (provided the facts in the petition remain valid); and
  2. The facts in the petition must be confirmed as valid annually by the corporation (at least two (2) months and fifteen (15) days after the fiscal year close; and
• All taxpayers selling property or services to such a corporation must file an annual report with the FTB identifying the number of the taxpayer’s employees within this state directly attributable to the construction or modification of a physical plant or facility located outside the state.

Suspension and Revivor (RTC §§23301 - 23311)

Failure to pay the Franchise Tax may result in suspension of the corporation (or forfeiture of its property), including invalidation by a court of contracts made during the suspension.

A corporation's rights may be revived through an application to the FTB by:

• Any stockholder;
• Creditor;
• A majority of the surviving trustees or directors thereof;
• An officer; or
• Any other person who has interest in the relief from suspension or forfeiture.

"Thus, Plaintiff’s certificate of revivor validates the filing of this Complaint. This ground for demurrer is now moot…However, Defendant also argues that a contract entered into by a suspended corporation is voidable…Rev. & Tax Code § 23304.1(a) provides: 'Every contract made in this state by a taxpayer during the time that the taxpayer’s powers, rights, and privileges are suspended or forfeited pursuant to Section 23301, 23301.5, or 23775 shall, subject to Section 23304.5, be voidable at the request of any party to the contract other than the taxpayer…' In turn Rev. & Tax Code § 23304.5 provides: "A party that has the right to declare a contract to be voidable pursuant to Section 23304.1 may exercise that right only in a lawsuit brought by either party with respect to the contract in a court of competent jurisdiction and the rights of the parties to the contract shall not be affected by Section 23304.1 except to the extent expressly provided by a final judgment of the court, which judgment shall not be issued unless the taxpayer is allowed a reasonable opportunity to cure the voidability under Section 23305.1[1]. If the court finds that the contract is voidable under Section 23304.1, the court shall order the contract to be rescinded. However, in no event shall the court order rescission of a taxpayer’s contract unless the taxpayer receives full restitution of the benefits provided by the taxpayer under the contract…Accordingly, this ground for demurrer is persuasive, but Plaintiff must be given an opportunity to obtain relief from the voidability provisions by making an application to the Franchise Tax Board.Longevity Time Management, Inc. Vs. L'antica Pizzeria Da Michele Usa, Llc, 19Stcv33888 (12/31/2019) (https://trellis.law/ruling/19STCV33888/longevity-time-management-inc-vs-lantica-pizzeria-da-michele-usa-llc/2019123153ac46).

The Court may strike out any pleading "not drawn or filed in conformity with the laws of this state." Code Civ. Proc. 436(b). "The grounds for a motion to strike shall appear on the face of the challenged pleading or from any matter of which the court is required to take judicial notice." Code Civ. Proc. 437. The judicially noticed documents (Exhibit D) indicate that James W. Brady, Inc. was suspended by the California Franchise Tax Board in 2014. However, WCR, LLC was not formed until 2019 (Exhibits E and F). As the powers of the corporation were suspended before WCR was formed (see Rev. & Tax. Code 23301 and 23301.5), it could not have transferred its assets to a successor corporation. WCR cannot, as a matter of law, be a successor entity such that it cannot file an Answer on behalf of James W. Brady, Inc. Bommel Vs Warren's Carpet Cleaning, 37-2019-00038756-Cu-Pa-Ctl (12/3/2019) (https://trellis.law/ruling/37-2019-00038756-CU-PA-CTL/bommel-vs-warrens-carpet-cleaning/201912039115ea).

Defendant demurs to the entire complaint on the ground that Sayari[1] Enterprises LLC has been suspended and therefore lacks capacity to prosecute any claim against it.

“With exceptions not relevant here, ‘the corporate powers, rights and privileges of a domestic taxpayer may be suspended, and the exercise of the corporate powers, rights, and privileges of a foreign taxpayer in this state may be forfeited,’ if a corporation fails to pay its taxes.” (Bourhis v. Lord (2013) 56 Cal.4th 320, 324 (quoting Rev. & Tax. Code, § 23301).) A corporation may also be suspended for failure to file a tax return. (Rev. & Tax. Code § 23301.5.) In general, a “corporation may not prosecute . . . an action . . . while its corporate rights are suspended for failure to pay taxes.” (Bourhis, supra, 56 Cal.4th at 324 (quoting Reed v. Norman (1957) 48 Cal.2d 338, 343).)

"Although corporations are unable to prosecute actions while suspended, raising corporate suspension as a reason to dismiss a case is disfavored. (Traub Co. v. Coffee Break Service, Inc. (1967) 66 Cal.2d 368, 370 [explaining that a “plea of lack of capacity of a corporation to maintain an action by reason of a suspension of corporate powers for nonpayment of its taxes ‘is a plea in abatement which is not favored in law [and] is to be strictly construed.”].) Nevertheless, given that the lack of capacity of a plaintiff must be raised by special demurrer or it is generally waived, Defendant properly raised the issue. (CCP § 430.20.)

"Unless “mandated by governing statute, the capacity of the plaintiff to sue is not an element of a cause of action and the plaintiff corporation need not allege it is qualified to do business in this state or that it has paid all state taxes.” (Center for Self-Improvement & Community Development v. Lennar Corp. (2009) 173 Cal.App.4th 1543, 1552–1553.) Thus, “the suspended status of corporate powers at the time of filing suit does not impede the trial court's jurisdiction to proceed, nor does a suspension after suit commences but before rendition of judgment deprive the court of jurisdiction or render the judgment void.” (Id. at 1553.)

"Here, Plaintiffs indicate that Sayari Enterprises will be revived before the hearing. (Oppo., at p. 5.) “A suspended corporation can regain its corporate powers by . . . applying to the Franchise Tax Board for a certificate of revivor.” (Ibid.) The “revival of corporate powers enables the previously suspended party to proceed with the prosecution or defense of the action.” (Ibid.)

"In light of Plaintiffs’ statement that they intend to revive Sayari Enterprises, LLC before the hearing, the demurrer on this basis is OVERRULED. (Cf. Cal-W. Bus. Servs., Inc. v. Corning Capital Grp. (2013) 221 Cal.App.4th 304, 312–313 [upholding the dismissal of an entity where a related entity “represented to the trial court that it had no intention of reviving the corporate powers of [the entity] by paying its delinquent taxes”].) If, however, Plaintiffs cannot show at the hearing that the entity has been revived or that they have taken reasonable and diligent steps to revive it, the Court will consider sustaining the demurrer without leave to amend." Fred Sayari Vs City Of Pomona, Bs170504 (11/12/2019) (https://trellis.law/ruling/BS170504/fred-sayari-vs-city-of-pomona/20191112f6716b)

Franchises Fees "Not" a Tax

“A franchise to use public streets or rights-of-way is a form of property and a franchise fee is the purchase price of the franchise.” (Jacks v. Cty. of Santa Barbara (2017) 3 Cal.5th 248 at 262 citing Stockton Gas etc. Co. v. San Joaquin Co. (1905) 148 Cal. 313, 319; City & Co. of S. F. v. Market St. Ry. Co. (1937) 9 Cal.2d 743, 749.) Historically, franchise fees have not been considered taxes. (See County of Tulare v. City of Dinuba (1922) 188 Cal. 664, 670 [franchise fee based on gross receipts of utility is not a tax]; City & Co. of S. F. v. Market St. Ry. Co., supra, 9 Cal.2d at 749 [payments for franchises are not taxes]; Barbara County Taxpayer Assn. v. Board of Supervisors (1989) 209 Cal. App. 3d 940, 949-950 [franchise fees are not proceeds of taxes].) Nothing in Proposition 218 reflects an intent to change the historical characterization of franchise fees, or to limit the authority of government to sell or lease its property and spend the compensation received for whatever purposes it chooses. (See Cal. Const., arts. XIII A, § 3, subd. (b)(4), XIII C.)

This understanding that restrictions on taxation do not encompass amounts paid in exchange for property interests is confirmed by Proposition 26, the purpose of which was to reinforce the voter approval requirements set forth in Propositions 13 and 218. (Jacks v. City of Santa Barbara (2017) 3 Cal.5th 248, 262-263 citing Prop. 26, § 1, subd. (f), Historical Notes, reprinted at 2B West's Ann. Cal. Const., supra, foll. art. XIII A, § 3, p. 297 ["to ensure the effectiveness of these constitutional limitations, [Proposition 26] defines a ‘tax’ ... so that neither the Legislature nor local governments can circumvent these restrictions on increasing taxes by simply defining new or expanded taxes as ‘fees’”].)

Although Proposition 26 strengthened restrictions on taxation by expansively defining "tax" as "any levy, charge, or exaction of any kind imposed by a local government" (Cal. Const., art. XIII C, § 1, subd. (e)), it provided an exception for "[a] charge imposed for entrance to or use of local government property, or the purchase, rental, or lease of local government property." (Id. citinv subd. (e)(4).)

“A franchise is a negotiated contract between a private enterprise and a governmental entity for the long-term possession of land. Franchise fees are paid as compensation for the grant of a right of way, not for a license or tax nor for a regulatory program of supervision or inspection.” (Barbara County Taxpayer Assn. v. Board of Supervisors (1989) 209 Cal. App. 3d 940, 949.) “In sum, franchise fees are paid for the governmental grant of a relatively long possessory right to use land, similar to an easement or a leasehold, to provide essential services to the general public.” (Id.)

“Surcharges” Defined

“The surcharge is not a tax if it is compensation for franchise rights.” (Jacks v. City of Santa Barbara (2017) 3 Cal.5th 248 at 267.) "[T]o constitute compensation for the value received, the fees must reflect a reasonable estimate of the value of the franchise." (Id.) "To constitute compensation for a property interest, however, the amount of the charge must bear a reasonable relationship to the value of the property interest; to the extent the charge exceeds any reasonable value of the interest, it is a tax and therefore requires voter approval." (Id. at 254.)