Under the Ralite Lamp Corporation case, the FTB must prove all of the following before holding a shareholder liable for a corporation?s tax:
- The corporation transferred property to the shareholder(s) for less than full and adequate consideration;
- At the time of the transfer and at the time the shareholder liability was asserted, the corporation was liable for the tax;
- The transfer was made after liability for the tax was accrued, whether or not the tax was actually assessed at the time of the transfer;
- The corporation was insolvent at the time of the transfer or the transfer left the corporation insolvent; and
- The FTB had exhausted all reasonable remedies against the corporation.
Ralite applies to the shareholder, not the corporation. You cannot use this decision until the FTB has made its assessments, given up trying to collect from the now-defunct corporation, and actively pursues the individual shareholder to pay the tax liability. Here is the chain of events:
- The shareholder gives up the business, doesn?t formally dissolve and stops filing tax returns.
- Because the taxpayer did not dissolve, the FTB sends the corporation a Demand to File notice.
- The taxpayer still does nothing, and the FTB sends a Notice of Proposed Assessment and begins billing the corporation. Assuming the corporation has no assets, there will be nothing for the FTB to collect.
- Eventually, the FTB may come to the shareholder (believe me, this is not fun for the shareholder!) and demands payment from the shareholder. At this time, you should invoke the Ralite decision, explaining that the taxpayer did not take assets without consideration. Enclose the following in the shareholder?s reply to the FTB:
- A copy of the final balance sheet which probably includes loans from shareholders to the corporation and capital stock as well as a negative earnings account;
- A list of assets with book value and fair market value. Indicate which shareholders took which assets; and
- A list of loans from each shareholder to the corporation, debts each shareholder paid, and the basis of each shareholder?s capital stock.
If it is clear that the shareholder did not receive more value out of the corporation than was owed, the FTB will generally stop pursuing the shareholder(s) and close the account.
Ralite and the LLC
The Ralite case applies to corporate shareholders. Although there are no cases on point, it would seem that the same criteria would apply to an LLC and its members, as an LLC has the same liability aspects as a corporation.
Ralite and the limited partnership
The Ralite decision does not apply to LPs. In the case of these partnerships, there is a general partner who is personally liable for the debts of the partnership. Unless the general partner is a corporation that itself would qualify for Ralite treatment, the general partner will be liable.