Last year, while researching an issue raised in a State Board of Equalization appeal, the Franchise Tax Board discovered that it had been erroneously imposing a penalty under Revenue and Taxation Code Section 19172 for late or incomplete limited liability company returns on thousands of single-member limited liability companies (SMLLCs), and had been doing so since 1997.
The FTB announced February 4 that it will partially remedy the problem by refunding the erroneously imposed penalty, with interest, to many of the affected taxpayers.
However, not all SMLLCs will be made whole. Because the FTB erroneously assessed the penalty for 16 years, the statute of limitations is closed for many (generally, the statute is closed on the 2008 and prior taxable years).
Some SMLLCs are not affected. SMLLCs that elected to be treated as corporations (not treated as disregarded entities for tax purposes) and multiple-member LLCs were not erroneously assessed the penalty, the FTB indicated. Only SMLLCs classified as partnerships were erroneously assessed the penalty, according to the FTB.
According to the FTB, the statute of limitations prohibits the agency from refunding even an erroneous assessment for a closed year. However, the FTB said it is “actively exploring alternative relief options, including potential legislation.” (CalTax: Under the Taxpayers’ Bill of Rights – R&TC Section 21004(c) – the FTB’s taxpayer advocate may “abate any penalties, fees, additions to tax, or interest assessed on a taxpayer” if the advocate determines that it is attributable to “erroneous action or erroneous inaction by the board in processing documents filed or payments made by taxpayers.” Unfortunately, that section stops short, because it also provides that relief may be granted only if the statute of limitations has not expired.)
Similar to federal law, the FTB may impose a penalty on any LLC that files and/or pays late.
In addition to the late-filing and late-payment penalties, the FTB – like the IRS – may impose a “per-partner” penalty under R&TC Section 19172 on an LLC if the LLC files a late or incomplete return (California Form 568). The FTB imposes the per-partner penalty even if all taxes have been paid on time. For California returns required to be filed on or after January 1, 2011, the penalty is $18 (it is $10 for returns required to be filed before January 1, 2011) multiplied by the number of partners for each month, or any part of a month, that the return is late or incomplete, not to exceed 12 months (five months before January 1, 2011) (R&TC Section 19172).
For an SMLLC that is disregarded for tax purposes, the maximum penalty is $216 for each taxable year for returns required to be filed on or after January 1, 2011 ($50 maximum prior to that).
According to the IRS’ long-standing position: “Specifically, an LLC with at least two members is classified as a partnership for federal income tax purposes, unless it files Form 8832 and affirmatively elects to be treated as a corporation. And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes (but as a separate entity for purposes of employment tax and certain excise taxes), unless it files Form 8832 and affirmatively elects to be treated as a corporation.” The rules are the same in California, and therein lies the problem: An SMLLCC has just one member, by definition, and the LLC is treated as part of the owner’s tax return (a disregarded entity). (CalTax: The SMLLC also must file a California LLC – Form 568 – return.)
An SMLLC cannot be treated as a partnership that is subject to the per-partner penalty. By definition, a partnership is a relationship existing between two or more persons who join to carry on a trade or business.
This month, the FTB will begin releasing letters in batches to approximately 8,500 SMLLCs, letting them know they will be receiving a refund of the penalty, with interest. The FTB will release the refunds to these SMLLCs within two weeks of the notification letter being released. The agency said it will release separate refund checks for each taxable year. (CalTax: It is unclear why the FTB can’t add up what it owes and send the taxpayer one check.)
Only SMLLCs whose statute of limitations was open as of June 26, 2013, will receive letters and refunds. According to the FTB, June 26 is “the date we discovered the misapplication of the penalty.” (CalTax: Under the Taxpayers’ Bill of Rights – R&TC Section 21004(b) – where “taxpayers have suffered or will suffer irreparable loss as a result of board action,” the FTB’s taxpayer advocate may toll the statute of limitations during the “pendency of a stay.”)
SMLLCs that have any balance due at the FTB will not get a refund, but will receive a notice that the refund was applied to the balance due.
The FTB expects to refund approximately $2.4 million in erroneously assessed penalties.
An SMLLC that received a per-partner penalty notice but failed to pay it will get an abatement notice from the FTB, even if the statute of limitations has closed. (CalTax: This is smart on the part of the FTB, as these taxpayers undoubtedly would be caught, or already have been caught, in California’s various amnesty programs.) The FTB estimates that there are 5,500 of these SMLLCs, with outstanding “penalties” totaling $1.4 million.
An SMLLC that was suspended by the secretary of state due to the FTB’s erroneous imposition of the per-partner penalty automatically will be revived by the FTB (via the secretary of state). Any suspension penalties imposed by the FTB will be abated. However, according to the FTB: “If the entity was suspended for reasons other than, or in addition to, failure to pay the section 19172 penalty, the entity will remain in suspended status and must meet the necessary revivor requirements before an overpayment of the penalty can be returned. Suspended LLCs which have not paid the section 19172 penalty will have the penalty abated but must meet the necessary revivor requirements to be revived to good standing.”
An SMLLC that is affected by the erroneously imposed penalty for the 2009 taxable year but does not hear from the FTB by early April should consider filing a claim for refund to protect the statute of limitations.
February 7, 2014
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