What is Corporate Suspension?
Every corporation formed in California, whether a mutual benefit corporation such as a homeowners association, a professional corporation or a major corporation, is registered with the California Secretary of State’s office. Upon incorporation, the corporation is assigned a corporate number and is required to file a Statement of Information (SI-100) on a biennial basis with the Secretary of State and to file tax returns with the Franchise Tax Board and pay taxes as required on an annual basis. In addition, all homeowners associations are now required to file a Statement of Common Interest Development (SI-CID) with the Secretary of State every two years as well. Failure to meet any of these corporate filing obligations can eventually lead to corporate suspension or revocation of corporate powers by the California Secretary of State or the California Franchise Tax Board.
Some commentators have opined that 10 percent or more of California‘s homeowners associations are suspended. Some of these associations may only exist on paper (i.e. articles were filed to establish the association but the project has never been built). With over 40,000 homeowners associations in California, that means that 4,000 to 5,000 associations may be suspended.
Why is this important?
Under California Revenue and Taxation Code (R&TC) Section 23304.1(a), “Every contract made in this state by a taxpayer during the time that the taxpayer’s corporate powers, rights and privileges are suspended or forfeited pursuant to Section 23301, 23301.5 or 23775 shall, subject to Section 23304.5, be voidable at the instance of any party to the contract other than the taxpayer.” Section 23304.5 requires that a lawsuit be brought by the other party in order for the contract to be voided. This could be problematic for a suspended association in the following situations:
- A dispute arises in a maintenance contract (roofing, painting, landscaping, etc.) and cannot seem to be worked out other than through the courts. If the association’s corporate powers are suspended, the other party could void the contract and/or the association has no ability to enforce the provisions of the contract since the association is suspended.
- The association is involved in construction defect issues that lead to litigation. Should the corporation be suspended, it cannot pursue the legal remedies permitted until the corporation is “revived”.
- The association is attempting to collect delinquent assessments from a homeowner. Liens could not be enforced or small claims could not be pursued if the association has its corporate powers suspended. The inability to secure the association’s assessments during a suspension period could result in lost assessments by the association.
- Without corporate powers, the association may not be able to enforce any provisions of its governing documents.
- Board members may not have the immunities provided by the Davis-Stirling Act if the corporation is not in “good standing” (suspended).
How does suspension occur?
Listed below are several scenarios that have occurred in my practice that I believe are not unique but occur regularly:
Suspension soon after incorporation.The association was incorporated by the developer’s attorney in 1983 and but was suspended in 1985 for failure to file tax returns or pay the California minimum tax. This 5-unit association was built, had a bank account with the manager’s tax ID number. Mailing addresses had changed from the attorney to one or more of the owners to the manger over the years. Notices sent by the FTB may not have been received or returned to the FTB due to the change in address. The suspension was discovered when management changed fifteen years later.
Suspension due to failure to file Statement of Information forms.As noted in the first scenario, association mailing addresses can change frequently. If the association uses an officer’s mailing address or its management company’s address as its mailing address, there is a strong possibility that the mailing from the Secretary of State will not be forwarded to the correct address when officers or managing agents change. Follow-up notices, penalty notices and suspension notices will likewise not be forwarded. This was a problem when the Statement of Information was an annual filing. Now that the statement is filed every two years, and that the Secretary of State no longer mails forms (just a postcard reminder) nonfiling will probably increase, resulting in more suspensions. Filing forms and requirements can be found at the Secretary of State’s website – www.sos.ca.gov. Missing one filing but making the subsequent filings does not “revive” the corporation. The penalty for failure to file the nonprofit statement of officers is $100 and is assessed through the Franchise Tax Board. At this writing, the Secretary of State is four months behind processing Statements of Information.
Recommendation:The Statement of Officers can be amended at any time during the two-year filing period at no cost. This form could be revised at the same time that signature cards are changed to reflect new officers, corporate mailing address change or change in agent for service of process. A fill-in form is available on the Secretary of State’s website – www.sos.ca.gov. The due date for these forms is the last day of the anniversary month of incorporation and even-numbered year if incorporated in an even numbered year. For example, an association incorporated March 12, 1998 would have its next set of filing due March 31, 2012.
Suspension for failure to file Franchise Tax Board Form 199.An association was suspended in 1987 because it had not filed a Form 199 form for 1986. 1986 was the last year that filing of the 199 was required of all nonprofit corporations regardless of revenues received. The $25,000 annual revenue minimum filing requirement for Form 199 was effective in 1987. In order to revive, the association had to file a 1986 Form 199 (in 2001!). My 1986 forms book was in storage so a colleague came to the rescue. (Now many but not all old forms are on the web) The association did not have a 1986 income statement so we used a 1987 one. (The FTB suggested that the form be filled in with “zeroes”) The 199 has a $10 filing fee. If the form is filed late, the fee increases to $65 plus interest.
Suspension for failure to file forms 100 and 199 and pay resulting penalties.While this can happen due to the address, officer or management changes noted above, it can also happen due to the negligence of the financial managing agent.
There are companies in California that provide financial management to associations. Some are owned by tax and accounting professionals who hold themselves out as providing all the necessary financial statement and tax preparation services needed by an association. This scenario can be attractive to a small association board as it allows them to feel confident that these matters are being taken care of by a professional and that the board has nothing to worry about. Be sure to ask whether annual income tax returns are being prepared. An officer of the association must sign them! In 2011, all tax-exempt homeowners association must file form 199 or an electronically filed 199N, if revenues are below $25,000 per year.
What happens when the tax returns are not filed? Demand notices and penalty notices are sent by the FTB. If no response is received, a series of letters threatening forfeiture of the corporation commence leading to the eventual suspension of the corporation.
I have seen a number of instances in recent years of the former financial manager providing 3-10 years worth of Federal and California income tax returns for filing by the association at the time of the changeover in financial management. I have received numerous calls over the years outlining this scenario. The managers know that tax returns are due annually and the 2005 returns are now five years late. These associations are going to incur late filing penalties as well as late payment and interest charges on any taxes due for both Federal and California. These associations have been suspended. Once these associations are revived, then they will have to go to small claims court to recover the penalties and interest incurred as a result of the negligence of the former financial manager. This is not an isolated incident. Many notices have to be ignored and thrown away for a corporation to be suspended.
How do you find out if an association is suspended?
Some information from the Statement of Information filing is maintained on a database on the Secretary of State’s website – www.sos.ca.gov/business/be. From there enter into “Business Search”.
Enter the corporation’s name or a portion of the name (if you are not sure of the exact name) to obtain name matches and corporate information. For example, I entered “Summerland Association” and 6 matches were returned. One of which was a suspended homeowners association, the Summerland Villas Homeowners Association. A “click” on the corporate name generated another report showing the corporation last reported mailing address and the agent for service of process. It does not show when the corporation was suspended, just that it is suspended.
How do you return the association to active status?
If your association is suspended, you need to contact the California Secretary of State and the Franchise Tax Board to determine what triggered the corporate suspension.
Secretary of State
1500 11th Street
Sacramento, CA 95814
If the corporation was suspended by the Secretary of State simply because the last Statement of Information or Statement of Common Interest Development was not filed, you may revive the corporation by sending a letter to the Secretary of State along with the delinquent Statements and the payment of any fees or penalties imposed. Request that the Secretary of State send a “Notice of Revivor” to the association and notify the Franchise Tax Board.
Franchise Tax Board
P. O. Box 942840
Sacramento, CA 94240-0000
My experience has been that speaking to one of the FTB Corporate telephone representatives has been fruitful in obtaining the information as to why the corporation was suspended.
The telephone representatives have information concerning why the FTB has suspended the corporation or whether the Secretary of State has suspended it. All required tax forms, tax payments, penalties and interest must be made with the FTB Form 3557 “Application for Certificate of Revivor”.
If the association is small, with little or no taxable income, the process is fairly straightforward and should not be too costly. I did have an FTB representative contact me once regarding the filing of a Form 100 for an association that had less than $100 in nonmembership income in the year in question (e.g. interest income). The association is not required to file Form 100 when nonmembership income is less than $100 (See Form 100 instructions and Publication 1028 – Guidelines for Homeowners Associations.) He wanted to know my authority. I cited the above FTB publications and never heard back from him.
Some associations, like the one cited in my first example, are suspended for failure to pay the minimum tax. This is because California tax-exempt status was not requested during incorporation. Form 3500 must be filed and approved by the Franchise Tax Board to obtain this status. It is not an automatic election like the Federal IRS Section 528 election. A brief questionnaire regarding association activities must be completed and 4 years’ financial information and signed copies of the association’s governing documents much be provided with the application. Upon qualification, the FTB will refund up to 4 years’ minimum tax for associations that qualify. Most residential associations should have no trouble qualifying for exempt status.
Do we have to disclose the suspension?
While the CIRA Guide (Accounting Standards for HOAs) does not provide any specific guidance, it is my opinion that an audited or reviewed financial statement should disclose suspended status in the notes to the financial statements. An association without corporate powers could have its financial situation severely impacted if it cannot collect its assessments or sue for damages incurred. This is a very significant disclosure.
Michael Gartzke, an ECHO member, is a Certified Public Accountant with a large homeowner association practice in the Santa Barbara area. He is also the coordinator of the South Coast Homeowners Association with a membership of about 140 associations.