Goodbye Tax Clearance Certificate

By Jeffrey M. Sulenski
Pahl & McCay
225 West Santa Clara Street
Suite 1500
San Jose, California 95113
408/286-5100 (phone); 408/286-5722 (fax)

Please understand that the information discussed in this Article is general in nature and is not intended to be legal advice. It is intended to assist owners and managers in understanding this issue area, but it may not apply to the specific fact circumstances or business situations of all owners and managers. You may need to consult applicable state and local laws. For specific legal advice, consult your attorney.

For anyone, who has been involved in dissolving a corporation in California, the greatest frustration has always been trying to get a tax clearance certificate from the Franchise Tax Board for the disappearing entity.  The corporation would file its dissolution documents with the Secretary of State, but the dissolution would not be deemed completed until the Secretary of State received a tax clearance certificate for the dissolving corporation from the Franchise Tax Board, and the Franchise Tax Board would take months to issue it.  While waiting for the tax clearance certificate, if the statement of information for the disappearing entity came due, the entity had to file that statement, even though it was being submitted after the eventual effective date of the dissolution. 

After years of frustration for business entities and their attorneys, the problem of getting timely tax clearance has finally been resolved.  During the summer of 2006, the California Corporations Code was amended, in essence, to eliminate the requirement for tax clearance for dissolutions, as well as for other transactions that required tax clearance.  Entities can now file their dissolution documents without having to apply for tax clearance certificates.  The Secretary of State will now file the documents, and, instead of waiting for the Franchise Tax Board to issue a tax clearance certificate, the Secretary of State will inform the Franchise Tax Board of the filing.

Although entities will no longer be frustrated with the slow tax clearance response from the Franchise Tax Board, they still must remember to file their final tax returns with the Franchise Tax Board.  The final tax return for an entity must be designated as a “final” return, and all outstanding obligations with the Franchise Tax Board must be paid in full before a disappearing or dissolving entity can truly close the books.  If an entity fails to file a final tax return or pay all of its outstanding taxes, the entity will be assessed penalties by the Franchise Tax Board until the entity is brought current. 

Not only did this recent amendment eliminate the need for a tax clearance certificate in dissolutions, it also potentially reduced the amount of taxes that may be due when a corporation dissolves.  Previously, a corporation was required to pay the minimum annual franchise tax for the year in which the corporation ceased to do business.  This requirement was probably a boon to the State of California.  For an operating entity, the minimum franchise tax is not much of a concern because the corporation’s tax liability each year is the greater of the minimum franchise tax or its income tax liability, and the income tax liability for most operating corporations exceeds its minimum franchise tax liability.  In the year a corporation dissolves, however, the income tax liability for the disappearing entity may well be less than the minimum franchise tax, so the State of California, in a sense, gets a parting gift from the dissolving entity.

Now, dissolving corporations will be required to pay the minimum franchise tax for the year in which it ceases to do business, if it files its final tax return and it completes its dissolution (i.e., files its certificate of dissolution with the Secretary of State) within 12 months after it files its final tax return.  Although the corporation would have to pay any income tax liability for that last year, it would not have to pay more than that if that income tax liability is less than the minimum franchise tax.

The new amendment also provides some relief for those corporations that filed their certificates of dissolution prior to the enactment of the amendment, but had never received tax clearance for whatever reason.  Many of these corporations are stuck in a twilight zone where they are out of business and inactive, therefore, they have no income tax liability, but, because they still technically exist on the records of the Secretary of State, they are assessed annual minimum franchise taxes until such time as they obtain their tax clearance.  Inevitably, these kinds of semi-dissolved corporations do not have the means to pay the additional taxes, and they cannot get their tax clearance without paying the franchise taxes.  The ultimate irony is that the franchise tax is assessed against these corporations for the privilege of being allowed to exist under California law, even though these corporations not longer want to that privilege. In fact these corporations are trying to surrender that privilege.  These corporations are in a corporate equivalent of purgatory.

The new amendment relieves these corporations from minimum franchise taxes that have accrued against them after they ceased doing business.  If they file final tax returns and pay any unpaid income taxes, they can finalize their dissolutions. 

Unfortunately, the new amendment also created a new problem for a limited number of dissolving entities who filed their certificates of dissolution before the enactment of the amendment, but had not received tax clearance before the amendment became effective.  The Franchise Tax Board will no longer issue tax clearance certificates, and the Secretary of State will not complete the filing of old certificates of dissolution because they do not meet the formal requirements for certificates of dissolution under the new amendment.  Under the new amendment, the certificate of dissolution must include a statement to the effect that a final franchise tax return has been or will be filed with the Franchise Tax Board.  These corporations will be required to file new, updated certificates of dissolution.

The new amendment has made life easier and perhaps cheaper for those who wish to dissolve their corporations.  Life should be better for everybody.  Corporations and attorneys will be happy to be able to dissolve entities more quickly and simply, and the Secretary of State will probably benefit from having more corporations dissolved rather than left abandoned and in limbo on the Secretary of State’s records.