Exemptions from minimum franchise/annual tax
FTB notices may lead taxpayers to pay the tax even though they are exempt.
Recently we’ve seen clients receiving notices and information from the FTB stating that they owe the $800 minimum franchise/annual tax even though they qualify for an exemption. This seems to be occurring in two different scenarios:
- Information notices sent to LLCs that formed in 2021; and
- Requests for returns for corporations and LLCs that formed within the last 15 days of a tax year.
In addition to the confusion caused by the initial notices, there have been some processing delays causing additional concerns.
Legislation enacted last year exempts LLCs from paying the $800 annual tax during their first year if they organize or register with the California Secretary of State’s (SOS) office during 2021 through 2023. Prior to 2021, the first-year exemption was only available to corporations.
Unfortunately, the FTB is automatically sending a Form FTB 5954, Requirements for Limited Liability Companies, to LLCs that organized or registered with the SOS during 2021. The notice states that it is not a tax bill, but “describes tax, fee, and filing requirements for LLCs.” The notice states that all LLCs doing business in California or organized or registered with the SOS must pay an $800 annual tax to the FTB and makes no reference to the first-year exemption. Many of our clients are receiving this information from the FTB and feel that they must pay the $800 for the first year.
We have raised this issue with the FTB, and they have stated they will modify the notice. Also make sure that, if you organized during 2021, you didn’t send a check after you received this notice from the FTB. If you did, a refund claim should be filed.
Forming in the last 15 days
California law also exempts corporations and LLCs from filing a return and paying the $800 minimum franchise and annual tax if:
- They did no business in California during the taxable year; and
- The taxable year was 15 days or less.
A corporation or LLC that forms during the last 15 days of the year in preparation to begin operations in the following year is not required to file a return or pay the $800 tax.
We typically recommend that you wait until the last 15 days of the year to form a new entity so that short period is essentially disregarded, and the entity can apply their first-year exemption to the next full year.
However, the FTB is taking the position that if an entity forms in those last 15 days, it may be doing business during that time period, and the entity must affirmatively state and verify that it was not actually doing business.
Notices going out
The FTB is sending the following notices for all new corporations and LLCs that did not file a return, even if they organized/registered in the last 15 days of the year:
- Form FTB 5834, Request for Past Due Corporation Tax Return; and
- Form FTB 5958, Request for Past Due LLC Return of Income.
Entities are given 30 days to respond to these notices. If a timely response is not received and processed, the FTB will then send Form FTB 4960, Demand to File. Unfortunately, due to recent mail processing delays, the FTB is sending the Forms 4960 to taxpayers that timely responded to the requests for returns, but whose response is still being “processed.”
In an effort to mitigate the impacts of the mail processing delays, the FTB has stated they will delay mailing any Forms 5834 and 5958 for the next 60 days.
What does “doing business” mean?
It’s also unclear what constitutes “doing business” during these fifteen days. The FTB simply stated that it is a “fact-intensive inquiry, requiring the consideration of the totality of the circumstances.” Does opening a bank account or registering a website domain constitute doing business?
At this point, we recommend that our clients who form during the last 15 days of the year wait until the beginning of the following year to begin any business operations. In that way you will be able to maximize the benefits of both the 15-day rule and the first-year-free rule.