This is always a hot topic:  A and B form a business in 2000 and incorporate with the state (for this discussion, it makes little difference if the business is an LLC or a corporation). From 2000 through 2006, things are great, and the business hums along. then, in 2007, their biggest client leaves, and the business plummets. At the end of 2007, they close the doors for good.

One problem: they never bother to dissolve the business.

In 2013, A gets a letter from the Franchise Tax Board:

“Dear A,

We noticed you’ve neither filed a return nor paid the $800 minimum tax for 2008, 2009, 2010, 2011 and 2012. Please send a check for (a ridiculous amount of money, including penalties and interest) to….”

Ok, so that’s a little more forthright than they’d actually be, but you get the point. So now what?

Well, talk to your CPA, and he or she is likely to tell you to just ignore the notices, and they’ll eventually stop coming. But…can you just ignore notices from the state? After all, they’re threatening to hold you personally liable if you don’t pay! Can they do that?

Maybe. You see, there’s this case, In re: Ralite Lamp Corporation (90-SBE-004), that addressed this very issue – whether or not the State of California can hold shareholders personally liable for the minimum tax. After all, it sounds plausible – the Board of Equalization (BOE) can hold individuals personally liable for sales tax, and the Education Development Department (EDD) can hold individuals personally liable for payroll ‘trust fund’ tax, so why not?

Because they can’t. There’s no statutory authority – not over shareholders, not over LLC members – for the FTB to take such an action. So why are they threatening to do it? Well….why not? Some sucker won’t know they can avoid the tax and pay it, and that’s something, right?

So…can you simply cite to Ralite (as your CPA would tell you) and move on? Not exactly.

You see, the parties in Ralite lost. That’s right – they lost. How did they lose? Because while the court found there was no statutory authority to hold them personally liable, there was authority in equity. Huh?

Equity is a legal principle beyond explaining here. To severely oversimplify, equity works to put parties back on equal footing. Fraud, for example, is an equitable action – and that was what at issue in Ralite: a fraudulent conveyance. In 1980, Ralite loaned its shareholders money, then in 1981 it gave them a distribution (without repaying the loan). No salaries were ever paid, and nothing was ever given in return for either the loan or the distribution. After the loans and distributions, the company was insolvent and couldn’t pay its tax. And that’s where the court found fault: “[B]ecause cash was distributed to the shareholders without adequate consideration and Ralite became insolvent, taxpayers are liable for Ralite’s tax.”

In other words, if there are sufficient funds in the company to pay the tax, and you transfer those funds out without adequate consideration (note: the court didn’t say compensation, it said consideration – the two are not the same), you may be held personally liable for the tax.

It should also be noted that 1990 precedes most LLCs, which means that Ralite has never been tested from an LLC perspective, only a corporate perspective. So while it may be true that the FTB won’t be able to pursue shareholders in a corporation, and it is likely thhey won’t pursue an LLC, you cannot say for sure that the FTB won’t try to pursue LLC members. But if they do, throw some Ralite on their fire and see what happens. Just make sure you’ve reviewed all the transactions and made sure nothing could be construed as a fraudulent transfer.