A recent United States Tax Court case illustrates the importance of keeping legal entities in good standing. In Medical Weight Control Specialists (TC Memo 2015-52), the taxpayer corporation received a statutory notice of deficiency from the IRS. Upon receipt of such a notice, a taxpayer has a period of 90 days within which to file an appeal in the Tax Court. The taxpayer filed its petition with the Tax Court within the required period.
The corporation’s privileges had previously been suspended by the state of California because it had not paid some required state taxes. After the petition was served on the IRS, the IRS moved to dismiss the petition because the corporation had been suspended by the state of California. Subsequent to the filing of this motion by the IRS, the corporation became reinstated under California law. Notwithstanding the subsequent reinstatement, the court held that the petition should be dismissed because the corporation’s powers were suspended during the 90 day window for it to file a Tax Court petition. In the Court’s view, that meant that the corporation did not have the power or authority under state law to file a petition. Therefore the court did not have any jurisdiction over the case.
We routinely see instances where legal entities have been suspended by their state of incorporation for a variety of reasons, including the nonpayment of required taxes or failing to file required returns or reports. This often happens when the purposes for which the entity was formed have been completed and the owners simply do not bother to go through the formal dissolution procedures. In many circumstances this does not turn out to be of any consequence. However, as this case illustrates, serious problems may arise if the entity is facing a tax deficiency and needs to file an appeal in the Tax Court.
In California, entities continue to be subject to the $800 minimum franchise tax for each tax year until they are formally dissolved. With applicable penalties and interest, these amounts can become significant over time. Under some circumstances the state may seek to collect these taxes from the owners of the entity. The best and safest procedure is to keep all legal entities in good standing with their states of incorporation and each state in which they are registered to do business, and then formally dissolve them when they have served their purpose.