March 17, 2007

Taxation of California Limited Liability Companies

The limited liability company (“LLC”) is a relatively new type of entity which is now available in almost every state in the U.S., including California. It has a combination of features which is not found in any of the other available business forms.

The LLC is very desirable for situations in which the California business owners wish to have partnership-type flow-through tax treatment, along with protection from personal liability. These are the same features which attract business owners to the S corporation, but the S corporation form has many limitations which restrict its use. Many California based businesses which would like to use the S corporation form are not eligible for S corporation status. In addition, the S corporation rules have many prohibitions and conditions which make it less attractive, even when it is an option.

Since corporations and non-resident aliens cannot be shareholders of an S corporation, the S corporation structure is not an option for enterprises owned by foreigners or for joint ventures involving corporations.

The desirable flow-through tax treatment (passing the tax consequences of losses, investment tax credits, and depreciation through to the individual owners) is regarded as “partnership” tax treatment, as opposed to “corporate” tax treatment. The tax return of the organization - the S corporation or LLC – shows the profits and losses, but the tax consequences of that informational return are prorated among the shareholders (or “members” in an LLC).

The key benefits of this flow-through of tax consequences are that profits and gains are taxed only once and taxed at the tax rate of each shareholder or member.

The tax treatment of LLCs can be more fully described as follows:

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March 14, 2007

Forming A Limited Liability Company In California

The creation of an LLC which will operate in Los Angeles County, Orange County, Ventura County, Santa Barbara County and throughout California requires the filing of articles of organization with the California Secretary of State’s office and execution of an operating agreement among the members. A qualified business attorney can be helpful in accomplishing this.

The articles of organization for an LLC formed under California law must set forth the LLC’s name, a date for its dissolution, a statement of purpose, the agent for service of process, and a statement indicating whether the LLC is to be managed by managers and not by all of its members or managed by only one manager.

The operating agreement is not a legal requirement under California law, but it is a necessity, since the parties will find it necessary to define all the rights, privileges and obligations of the members of the LLC. The operating agreement should contain provisions addressing at least the following topics:

1. The rights and duties of members;

2. Contribution of cash, property, or services by members and other issues relating to capital structure;

3. Allocations of profits and losses and other tax consequences of the LLC;

4. Distributions to the members;

5. Maintenance of capital accounts, accounting records and financial information, and delivery of financial reports and tax information to the members;

6. Meetings of members, meetings of managers, and voting requirements;

7. How the LLC is to be managed, whether by the members, by a management group of members, or by hired management;

8. Disposition of interests of members, termination of memberships, assignment of membership interests, admission of additional members, and withdrawal of members;

9. Rights of the LLC or other members to buy out the interest of a member under specified circumstances;

10. Rights of the LLC or other members to buy out the interest of a deceased member;

11. Dissolution of the LLC; and

12. Procedures for amending the operating agreement.

Mitchell A. Port, at (310) 559.5259 is available to consult on these matters as well as other business transactions.

March 12, 2007

California Limited Liability Companies

The LLC is not the perfect entity for any business in California. All aspects of the LLC must be considered for each business situation.

An important limitation in California is that most licensed occupations are prohibited from using the LLC. If the business must hold any type of state license, check out the potential licensing limitations on the LLC first. The broad prohibition on using an LLC for state licensed activities has been an unwelcome surprise for many business people.

Another concern in California is that LLCs are subject to the minimum franchise tax of $800, plus a gross receipts tax according to a schedule. The gross receipts tax kicks in at $900 on gross receipts of $250,000 to $499,999, $2,500 on gross receipts of $500,000 to $999,999, $6,000 on gross receipts of $1,000,000 to $4,999,999, and $11,790 of gross receipts of $5,000,000 or more.

In California, S corporations pay a 1.5% tax on their net income. LLCs are taxed on their gross receipts. So depending on the entity's ratio of gross receipts to taxable income, there may be an advantage to operating as an S corporation. For example, assume a grocery stock with $10,000,000 of gross receipts and profits of $200,000. As an LLC, the grocery store would pay $8,585 in taxes (the maximum for gross receipts, $800 + $11,790, but only $3,000 as an S corporation (1.5% of $200,000). However, if the entity earned $5,000,000 in income, as an LLC it would still pay the maximum of $12,590 in taxes, but as an S corporation, it would pay $75,000 in taxes (1.5% of $5,000,000). Thus, understanding the gross receipts to net income ratio of the entity is extremely important when deciding whether to operate as an S corporation or LLC.

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March 9, 2007

My Bank Account Was Levied; The IRS Just Levied My Wages

When I worked as a revenue officer for the IRS in Los Angeles County, California, I took your money out of your bank account or levied your salary earned at your job by simply mailing a form – a levy - to the bank or to your boss. Those were the good ol’ days. These days, as a tax lawyer I help those who are at the receiving end of a levy.

The IRS issues a levy to satisfy a tax debt by seizing your property. Levies and liens are not the same. To secure its claim for unpaid taxes, the IRS files a lien in the county where you have property, be it in Los Angeles County, Santa Barbara County, Ventura County, or Orange County. In contrast, a levy actually takes the property to satisfy your tax debt.

If your property is levied or seized, contact your tax attorney first and then have your attorney contact the employee who took the action. You also may ask the manager to review your case. If the matter is still unresolved, the manager can explain your rights to appeal to the Office of Appeals.

The IRS may seize and sell any type of real or personal property that you own or have an interest in throughout the United States if you do not pay your taxes (or make arrangements to settle your debt). For instance, the IRS

Can seize and sell property that you hold such as your car, boat, or house, or --

Can levy property that is yours but is held by someone else such as your wages, commissions, bank accounts, California State tax refund, licenses, rental income, accounts receivables, retirement accounts, dividends, and the cash loan value of your life insurance.

Often, the IRS will levy only after 3 requirements are met:

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March 6, 2007

The IRS “Liened” My Property So What Do I Do Now?

Liens give the IRS a legal claim to your property as security or payment for your tax debt. A Notice of Federal Tax Lien is filed in the California county where you live whether it is Los Angeles County, Ventura County, Santa Barbara County or Orange County.

The lien may be filed only after the IRS assesses the tax liability, sends you a Notice and Demand for Payment which is a bill that tells you how much you owe in taxes, and you neglect or refuse to fully pay the debt within 10 days after being notified about it. If you want to pay in installments, the IRS will likely file a lien until the debt is paid in full. In either case, consult with a tax attorney immediately.

Once these requirements are met, a lien is created for the amount of your tax debt and may include some penalties and interest. By filing notice of this lien, everyone knows that the IRS has a claim against all your property, including property you acquire after the lien is filed. The courts use this notice to establish priority of claims against you in certain situations, such as sales of real estate or bankruptcy proceedings.

All your property such as your house or car and all your rights to property such as your accounts receivable, if you are a business, is attached by the lien. To add insult to injury, the IRS charges you the fee required by the county to record the lien.

Once a lien is filed, your credit rating will be harmed. Getting a loan to buy a house or a car, getting a new credit card, or signing a lease will probably be very difficult because few will extend credit to you when the IRS has a prior claim. Therefore, resolving your tax liability as quickly as possible before the lien is filed is important.

You can obtain a Release of the Notice of Federal Tax Lien within 30 days after you satisfy the tax due (including interest and other additions) by paying the debt or by having it adjusted, or within 30 days after you guarantee payment of the debt by submitting a bond accepted by the IRS. Refer to Publication 1450, Request for Release of Federal Tax Lien. Usually 10 years after a tax is assessed, a lien releases automatically if it has not been re-filed. Just call the IRS to get the pay-off amount.

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March 3, 2007

Beware of Tax Cheats in California

Tax scams are all around us. Don’t fall victim to them! These schemes take several forms, ranging from promises of large tax refunds to illegal ways of escaping your tax obligations. These scams emanate from everywhere including Los Angeles, Santa Barbara, Orange, Ventura; no county in California is immune.

No matter what you are told, remember these three things:

Sign a tax return only after looking it over to make sure it is accurate.

Anyone who promises you a bigger refund without knowing your tax situation is probably misleading you.

You are responsible and liable for the content of your income tax return.

Here’s a sample of some common tax schemes to be avoided:

Frivolous Arguments: Scam artists have been known to make absurd claims that the Sixteenth Amendment concerning congressional power to establish and collect income taxes was never ratified; that wages are not income; that filing a return and paying taxes are merely voluntary; and that being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy. Don’t believe these or other similar claims. Such arguments are false and have been thrown out of court. You always have the right to contest their tax liabilities in court but you have no right to disobey the law.

Telephone Tax Refund Abuse: Some individual taxpayers have requested large and improper amounts for the special refund of the telephone tax. In some cases, taxpayers appear to be requesting a refund of the entire amount of their phone bills, rather than just the three-percent tax on long-distance and bundled service. The IRS is investigating potential abuses. You may request a refund on your 2006 tax return if you paid long distance telephone excise taxes after February 28, 2003 and before August 1, 2006. Generally, the telephone tax refund will be $30 to $60.

Identity Theft: The IRS does not use e-mail to contact us about issues related to our accounts. If you have any doubt whether a contact from the IRS is authentic call 800-829-1040 to confirm it. It pays to be choosy when it comes to disclosing personal information. Identity thieves have used stolen personal data to access financial accounts, run up charges on credit cards and apply for new loans. The IRS is aware of several identity theft scams involving scammers posing as the IRS itself.

Return Preparer Fraud: Avoid being victimized by dishonest tax return preparers who can cause endless headaches for you. These preparers derive financial gain by skimming a portion of your refund and charging inflated fees to prepare your tax return. They attract new clients by promising large refunds. Beware.

If you think you're about to be scammed, call a qualified tax attorney to discuss it before it happens. Call Mitchell A. Port at (310) 559-5259.