New California Law Governing Dissolution of Inactive California Nonprofit Corporations

New California Law Governing Dissolution of Inactive California Nonprofit Corporations

Effective January 1, 2016, inactive nonprofit corporations that are eligible for dissolution under the newly enacted AB 557 may voluntarily dissolve or be administratively dissolved by California authorities with potential abatement of prior year state franchise tax, interest, and penalties.The new law, found at Sections 5008.9, 6610.5, 8610.5 and 9680.5 of the California Corporations Code and Section 23156 of the Revenue and Taxation Code, is intended to “establish a streamlined process to efficiently dissolve a nonprofit corporation” and ensure that “nonprofit corporations that have been suspended or forfeited tax-exempt status are no longer able to do business in the state.”

This new law addresses the problem of several hundreds, maybe thousands, of inactive and suspended California and foreign nonprofit corporations sitting on the state’s books. Many of these nonprofits have lost their tax exempt status through failure to file required annual reports and the organizations have been accruing California taxes of at least $800 every year, in addition to penalties and interest. Some of these want to be reinstated; others simply want to dissolve but can’t.

Why not? In order to dissolve, California nonprofits must first lift their suspension. To lift the suspension, nonprofits must either pay all prior year taxes, penalties, and interest or seek retroactive reinstatement of their exempt status. For many nonprofits, the prior year taxes amount to thousands of dollars they do not have. But if they seek reinstatement, they find that they will not qualify because nonprofits that are inactive do not qualify for exemption. As a result, Boards simply walk away from these defunct nonprofit entities, and the nonprofits remain on the records of the Franchise Tax Board (FTB) and Secretary of State.

AB 557 fixes this problem twofold:

First, it permits a nonprofit to request abatement of the minimum franchise tax, penalties, and interest due for prior years so long as the nonprofit establishes that it has ceased all business operations and dissolves within 12 months of the request for abatement. Notably, this provision only applies to nonprofit that received exemption but then had it revoked or that never conducted operations at all. It does not apply to nonprofits that engaged in operations in California but never applied for and received exempt status. So it does not apply to the church, for example, that opened and operated in California and never filed for tax exempt status or filed any returns because it believed as a church that it was exempt from any filings.  

Second, it permits the California Franchise Tax Board and the Secretary of State to effectively clear its books of defunct nonprofits through an administrative dissolution process. The process requires notice to the nonprofit and gives the nonprofit an opportunity to object to the administrative dissolution.

In addition, the new law provides the same short form dissolution process to nonprofit corporations in existence for less than 24 months that has previously been available other corporate types in California.

Voluntary Dissolution and Abatement of Back Taxes

The new Section 23156 of the Revenue and Taxation Code (R&TC) authorizes the Franchise Tax Board to abate the unpaid annual $800 minimum franchise tax, interest, and penalties for each year that a nonprofit certifies, under penalty of perjury, that it was not doing business in California.

In this context “doing business” is defined by R&TC Section 23101 as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”

To qualify the nonprofit corporation must satisfy one of the following conditions:

  1. It operated and previously obtained tax-exempt status with the Franchise Tax Board but the FTB revoked its tax-exempt status due to the organization’s failure to file annual FTB information returns;
  2. It operated and previously obtained tax-exempt status with the Internal Revenue Service, but the IRS revoked its tax-exempt status due to its failure to file annual IRS information returns; OR
  3. It was never doing business in California within the meaning of R&TC Section 23101 at any time after the time of its incorporation in California.

This abatement does not apply to any income tax that would have been due above the annual minimum franchise tax, to unrelated business income tax, or to associated penalties or interest.

In addition, the nonprofit must dissolve within twelve months from the date of filing the request for abatement. Failure to dissolve in that timeframe will cancel the abatement.

The Franchise Tax Board may end up prescribing rules and regulations to administer this abatement authority.

Clearly this new provision is of benefit to inactive nonprofits that want to dissolve without first paying prior year franchise taxes or seeking reinstatement. It is unclear however whether there is any benefit for a nonprofit to dissolve under this voluntary dissolution as opposed to just waiting for administrative dissolution described below. One could argue that a nonprofit Board or officers have gone much farther in meeting their fiduciary duties to the nonprofit by seeking voluntary dissolution as opposed to waiting for the FTB to dissolve the organization.

Administrative Dissolution

The new Section 5008.9 of the Corporations Code subjects any California nonprofit public benefit, mutual benefit, or religious corporation, and any foreign nonprofit corporation qualified to transact business in California, to administrative dissolution if the Franchise Tax Board has suspended the corporate powers of the nonprofit for a consecutive period of 48 months.

The process looks as follows:

  • The Franchise Tax Board sends a notice to the last known address of nonprofit in the records of the FTB.
  • The FTB also sends the name and corporate entity number of the nonprofit to the California Secretary of State and the California Registry of Charitable Trusts.
  • The Secretary of State lists the nonprofit on its website as a nonprofit subject to pending administrative dissolution and provides instructions for the nonprofit, if desired, to send a written objection to the FTB. This listing serves as 60 days’ notice of the dissolution.
  • If the nonprofit sends a written objection within the 60 day period, the nonprofit has an additional 90 days to pay or satisfy all accrued taxes, penalties, and interest and to file a current Statement of Information with the California Secretary of State. The nonprofit will be eligible for one additional 90 day extension. Once payments and filings are made, the dissolution will be cancelled.
  • If the nonprofit does not send a written objection within the 60 day period, or does not pay the applicable amounts within the allotted time period, the nonprofit will be dissolved. The Secretary of State will issue a dissolution certificate.

As part of the dissolution, the nonprofit’s liabilities for its past due annual $800 minimum franchise tax, interest, and penalties are abated. However, the nonprofit’s liability to creditors and the liability of nonprofit directors or other related parties will not be discharged. The California Attorney General will continue to have authority to enforce liabilities of the nonprofit. For example, if a nonprofit or its directors or officers have engaged in improper financial practices in violation of California’s charitable trust laws or improper employment practices in violation of federal and state employment laws, those liabilities will remain despite dissolution.

Short Form Dissolution

For nonprofits incorporated less than 24 months prior to a proposed dissolution and that have issued no memberships, a short form dissolution is available. A majority of directors, or if applicable, incorporators, can sign and verify a certificate of dissolution stating all of the following:

  1. That the certificate of dissolution is being filed within 24 months from the date the articles of incorporation were filed.
  2. That the corporation does not have any debts or other liabilities, except those tax liabilities in line (3) and other liabilities (described below) that remain with the nonprofit despite dissolution.
  3. That the tax liability will be satisfied on a taxes-paid basis, or that a person or corporation or other business entity assumes the tax liability, if any, of the dissolving corporation and is responsible for additional corporate taxes, if any, that are assessed and that become due after the date of the assumption of the tax liability.
  4. That a final franchise tax return has been or will be filed with the Franchise Tax Board.
  5. That the corporation was created in error.
  6. That the known assets of the corporation remaining after payment of, or adequately providing for, known debts and liabilities have been distributed as required by law or that the corporation acquired no known assets, as the case may be.
  7. That a majority of the directors, or, if no directors have been named in the articles or have been elected, the incorporator or a majority of the incorporators authorized the dissolution and elected to dissolve the corporation.
  8. That the corporation has not issued any memberships, and if the corporation has received payments for memberships, those payments have been returned to those making the payments.
  9. That the corporation is dissolved.

This certificate of dissolution must be filed with the Secretary of State. The nonprofit will be dissolved upon filing.

Notwithstanding the administrative dissolution, its liability to creditors and the liability of its directors or related persons is not discharged. The liability of the directors of, or other persons related to, the administratively dissolved corporation is not discharged. The California Attorney General will continue to have authority to enforce liabilities of the nonprofit.

Written by Cameron Holland.