The accidental LLC and 'dying on the vine'

Dear Alex:

Four years ago, I formed an LLC with the secretary of state because I was planning to start a business. Plans changed and I never started conducting business. I forgot all about the LLC until recently when I received notice of delinquent franchise taxes.

What do I do?

This happens more frequently than you might think.

In the excitement of planning for a new business, people will often form their LLC or corporation before they are ready for the entity to start conducting business, and the business plans may never come together.

Plans change, people change their minds, perhaps the owners realize another company has already cornered their target market, and the business idea never germinates into an operating business.

The business entity is forgotten, annual fees are never paid, and seemingly out of nowhere years later the Franchise Tax Board starts to send demand letters to the entity’s registered address. Demand letters from a tax collector can be distressing.

The California minimum franchise tax for corporations and LLCs is $800 per year. A neglected business entity can quickly accrue thousands of dollars in franchise taxes. It may then be too late to dissolve the entity without substantial tax cost, as the secretary of state will not allow dissolution until the Franchise Tax Board has been satisfied.

Many people will simply pay the tax to avoid complication and stress. Others cannot afford the payment or do not believe that they should be required to do so.

In the case of limited liability entities such as corporations and LLCs, one of the primary benefits of forming the entity is that the liabilities of the entity (excluding personally guaranteed debt and certain payroll taxes) generally do not extend to the owner’s home and other personal assets.

As long as the liability protection has not been terminated by the owner’s conduct, the franchise tax liability should not extend to the individual members or shareholders of the company. At this stage, some owners make the business decision to let the entity “die on the vine.”

This means they allow the entity to remain in existence until its standing with the secretary of state’s office is suspended, and by time and neglect it ceases to exist for all other intents and purposes.

The Franchise Tax Board is likely to continue its collection efforts and may eventually send demand letters to the individual owners. At that point it is up to the owners themselves to assert the defense of corporate liability protection.

Alex Myers is a business attorney with Myers & Associates in Napa. Reach him at alex@myers-associates.com or 707-257-1185. The information provided in this column is not intended as legal advice, nor does it create an attorney-client relationship. The information is not a comprehensive analysis of the law — if you need legal advice, contact an attorney.

This column originally ran in the Napa Valley Register on March 1st, 2016. You can read it on the Register's website here: "The accidental LLC and 'dying on the vine'"