The Importance of Paying Your California Franchise Tax
Every year, companies that are organized as California corporations, California S-Corps, California limited liability companies (LLCs), and California limited partnerships (LPs) must pay taxes to the California Franchise Tax Board. Failure to do so causes your company to lose its “good standing.” In the case of corporations, under Cal. Rev. & Tax Code § 23301, failure to pay the annual franchise tax results in the suspension of the corporation’s “corporate powers, rights and privileges” including the corporation’s right to bring a lawsuit while the taxes are unpaid. Moreover, under § 23304.1, contracts made by the corporation in California while suspended may be found voidable by a court.
Recent Case: Cal-Western Bus. Services v. Corning Capital
The importance of keeping your company in good standing and paying your franchise tax is illustrated by the recent case of Cal-Western Business Services, Inc. v. Corning Capital Group, 221 Cal.App.4th 304, 163 Cal.Rptr.3d 911 (2nd Dist. 2013).
In that case, Cal-Western Business Services (“Cal-Western”) was assigned all the rights and interest in a certain judgment then owned by Pacific West One Corporation (“Pacific West”) in the principal amount of $317,882 and accrued interest of $327,857. However, at a time when the assignment was written and executed by Pacific West, its corporate powers were suspended for failure to pay its franchise taxes. In 2008, Cal-Western sued the judgment debtor (Corning Capital) to recover the $640,000+ judgment. In the subsequent eight years of litigation, Pacific West never filed with the Franchise Tax Board to revive its corporate powers.
So the question for the court was whether Cal-Western could continue its lawsuit to enforce payment of the Pacific West judgment as the assignee of a suspended corporation.
The court held they could not. By law, Cal-Western “stepped into the shoes” of the assignor (Pacific West) and, therefore, Cal-Western’s corporate status was deemed to be that of the assignor (for purposes of enforcing that particular judgment). Since, as a suspended corporation, Pacific One could not maintain the lawsuit, then Cal-Western could not maintain the lawsuit. Cal-Western’s case was dismissed by the trial court and the dismissal was affirmed on appeal.
Note that Corning Capital could also have challenged enforcement of the $640,000+ judgment on the basis of Cal. Rev. & Tax Code § 23304.1 which, as discussed above, allows contracts to be declared void if such contract was made by a suspended corporation. In the Cal-Western case, the assignment, a type of contract, was made by Pacific West when Pacific West’s corporate status was suspended. As such, the assignment could have been voided. However, for procedural reasons, the court did not need to reach that basis for throwing out Cal-Western’s case.
Lessons for California Corporations
Cal-Western illustrates just one consequence of failing to pay the corporation franchise tax.
Note that a suspended corporation can revive itself by doing the following:
- Filing an application with the California Secretary of State;
- Paying all delinquent taxes, including penalties, fees, and interest;
- Filing any delinquent tax returns, and
- Filing an application to seek relief from the voidability of its contracts.
As can be seen, corporate law can be complex and confusing. You and your business need the assistance of talented and dedicated business and corporate attorneys to ensure that your corporation is formed and maintained correctly.
Contact San Diego Corporate Law
For further information, please contact Michael J. Leonard, Esq., of San Diego Corporate Law. Mr. Leonard has the experience to help you keep your corporation, LLC, or LP in good standing. Mr. Leonard can also help you form your corporation, LLC, or LP, create and review buy-sell agreements, create and assist in executing business contracts, and assist with any business-related matter. Contact Mr. Leonard by email or by calling (858) 483-9200.