Sometimes a California limited liability company (LLC) or California corporation dissolves and files a final tax return which shows it has a refund coming, but the refund is $800 short. How could this happen? It’s because the Franchise Tax Board (FTB) may deduct $800 and apply it to next year’s taxes.
Let’s say that a business entity files a tax return and has a refund coming. In that case, the FTB computer looks to see if the business entity had paid the tax for the next year (estimated tax for a corporation). If the next year’s tax payment is past-due, the FTB may take $800 out of the refund and apply it to the next year’s tax. The intent is to help the taxpayer avoid penalties and interest for late payment of the tax for the next year.
But if the entity is dissolving and filing its final tax return (and the appropriate box on the tax return is marked to show that it’s the final tax return), there shouldn’t be a next year for the entity, let alone a tax for that next year.
Here’s the rub. Although a California LLC or corporation files a tax return marked “Final,” the termination of the entity for tax purposes does not occur until the proper paperwork is filed with the California Secretary of State. In the case of an LLC, the minimum paperwork is ordinarily a certificate of cancellation. In the case of a corporation, the minimum paperwork is ordinarily a certificate of dissolution. In some cases, additional paperwork might be needed, particularly if the entity has been delinquent on its filings with the Secretary of State.
If the paperwork is not timely filed, the business entity continues to exist for tax purposes until the next tax year. (And it will continue until it files the correct paperwork with the Secretary of State.) In that case, it incurs the next year’s taxes. This applies even if the tax return filed was marked “final.”
Once the Secretary of State notifies the FTB that the correct paperwork has been filed, assuming the correct paperwork has been timely filed, the FTB should remit the $800 balance to the taxpayer (less, of course, any other amount that may be owing).
But if the taxpayer neglects to file the paperwork on time or never files the paperwork with the Secretary of State, then the $800 deducted from the tax refund will be consumed by being applied to the next year’s tax. And the business entity will probably incur penalties and interest in succeeding years if the paperwork is not filed before the end of the next year.
Filing the correct paperwork with the Secretary of State prior to filing the final year’s tax return may avoid this problem. There are other pitfalls to terminating a California entity, and it can pay to have competent legal assistance in the process.
If you have a California business entity to wind up, dissolve, or terminate, I can help.