The High-touch Legal Services® Blog • For Startup Companies

California’s $800 per year minimum franchise tax applies to both corporations and limited liability companies. Many people do not realize, however, that the tax can be avoided – at least, for a short time.

As explained in Franchise Tax Board Publications 1060 (for corporations) and 3556 (for LLCs), there is a “15-day rule” or “15-day exception” stating that the minimum franchise tax need not be paid for an initial tax year if:

• The corporation or LLC was formed (Articles filed with the Secretary of State) during the last 15 days of the entity’s tax year, and
• The entity conducted no business during that period.

So, if an entity has a tax year ending December 31 (as most do), then it can be formed on December 17 or later, and it will not have to pay the minimum franchise tax until the following year.

Dana H. Shultz, Attorney at Law  +1 510 547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Almost two years ago, I wrote about how Delaware corporations with no-par-value stock can find themselves obligated to pay extraordinarily high franchise taxes (In Delaware, No-Par-Value Can Cost a Bundle). Yesterday, a reader of this blog pointed out that IncNow, an online incorporation service, virtually lures naive customers into this tax trap.

Here is what the reader reported to me:

• IncNow’s default assumption is that no-par stock will be issued.
• IncNow does not invite the user to specify a par value (in contrast to LegalZoom, for example, which does).
• IncNow’s representative said that the reader “could assign a par value to shares, under special requests at the bottom of the checkout form” [emphasis added].

In my opinion, considering par-value designation a “special request” is ridiculous on its face. But doing so with tens or hundreds of thousands of dollars at stake is grossly irresponsible. As a result, IncNow has been added to this blog’s Hall of Shame.

Dana H. Shultz, Attorney at Law  +1 510 547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

This post is based on a question that I answered on LawPivot: Q. I have a web business that has been adversely affected by the termination of Amazon’s affiliate program in California, where I currently run the business, resulting from the state’s new sales tax law. Does each state have its own requirements as to what constitutes “doing business” in that state, and is there any way I could maintain CA as my primary place of residence, were I to incorporate in a different state?

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Significant responsibilities or liabilities can depend on whether one is “doing business” in a state. As this post explains (principally referring to California law for examples), “doing business” can mean three different things in three different contexts.

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Although failure of a company is no fun, this morning I received an e-mail on this topic that made me smile. Sent with the subject line “Sell Those Dogs!”, the e-mail discusses how ET Brutus* buys the securities of dead or dying companies so owners can recognize losses for tax purposes.

The following excerpts from the ET Brutus website summarize the company’s value proposition:

ET Brutus helps private equity investors easily and legally recognize investment losses in the tax year of their choice. Specifically, it purchases stock of dead or dying companies for $1 plus a small service fee of $25 per position so the investor can recognize the tax loss.

By selling your interests to ET Brutus, you have a provable legal event that allows the tax loss to be recognized. Some companies may take a year or more to officially close. With ET Brutus, you can recognize the loss in the tax year of your choice.

I’m not a tax expert, so I don’t offer tax advice. If you’re considering such a transaction, check first with your tax advisor.

* If you do not catch the pun in this company’s name, check out Wikipedia’s discussion of “Et tu, Brute?”, then look closely at the logo, above.

Related post: How to Kill Your Company when that’s the Only Choice

Dana H. Shultz, Attorney at Law  +1 510 547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

In “How Many Shares Should My Corporation Authorize and Issue?“, I warned that “If you are forming a Delaware corporation with a large number of shares, be sure to specify a low par value, such as $0.0001 per share, to avoid having to pay excessive annual fees to the state.” This post (based on a Quora answer that I provided) gives more details about this issue.

There are two methods for calculating Delaware’s annual franchise tax.

For no-par shares, the method that produces the lower tax (Authorized Shares Method) still produces a tax of many thousands of dollars for a corporation having millions of authorized shares - up to $180,000.

For  a startup with millions of low-par-value shares and no assets, the Assumed Par Value Capital Method yields the minimum tax of $350 (increased in 2010 – used to be $75).

Dana H. Shultz, Attorney at Law  +1 510 547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Late last year (see Foreign Company Alert: Obtaining an EIN may be your Biggest Challenge in the U.S.), I wrote about the procedure by which a U.S. entity may obtain an Employer Identification Number (EIN) when its foreign owner lacks a social security number (SSN). I recently answered an Avvo question about what to do when the specified procedure is not followed.

The questioner’s accountant had used his (the accountant’s) SSN to obtain an EIN online for his client’s corporation because the client’s foreign owner had no SSN. The client suspected – correctly – that this was not the right thing to do (the Internal Revenue Service “does not authorize” this action).

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I recently met two individuals who formed a business partnership. They were pretty informal about the process: They had no written partnership agreement. More surprisingly, they had not obtained an employer identification number (EIN) from the Internal Revenue Service.

Failure to obtain an EIN was a legal mistake. The IRS’s Do You Need an EIN? page states that when a partnership is formed, it must obtain an EIN.

Even worse, the failure was a serious business and personal mistake. When customers asked for the partnership’s EIN, one of the partners provided her social security number. As a result, at year-end the IRS will think all partnership income was earned by that partner! If her return is audited, she will have quite a bit of explaining to do.

Bottom line: If you form a partnership, get an EIN.

Related post: Beware the Unintended Partnership

Dana H. Shultz, Attorney at Law  +1 510 547-0545  dana [at] danashultz [dot] com
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact a lawyer directly.

Some companies are formed as S corporations to avoid “double taxation”: The corporation does not pay federal income tax. Instead, income flows through to the shareholders, who pay income taxes (as in a partnership).

This potential tax benefit is available, however, only if stringent requirements are met. Most notably:

• There must not be more than 100 shareholders.
• Permissible shareholders are limited to individuals (other than non-resident aliens), estates, tax-exempt organizations, and certain qualified trusts.
• Only one class of stock is permitted.

Failure to meet a requirement, even if inadvertent, results in loss of S corporation status.

Entrepreneurs should think carefully about whether S corporation status is appropriate for the long term. Here’s why.

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On a couple of occasions, I have worked with founders whose corporations (prior to retaining me) issued a small number of their authorized shares.

In one instance, four founders formed a corporation that was authorized to issue 50,000 shares, but had issued (to themselves) fewer than 400 of those shares. They asked me to help reallocate shares among them because, as time had passed, they saw that their respective contributions to the business differed from what they initially had expected.

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