Category: Business & Contract Law

A Rancho Cucamonga dentist sells her practice to a dental group for $1 million plus up to $400,000 more if collections hold for two years, and stays on as an associate. Eighteen months later the group has moved a hygienist to Ontario and dropped Saturday hours, and the earnout statement says she missed by four percent. Delaware has spent years on a far bigger version; California has its own rules and a tax side.

What does a buyer owe a California seller while the earnout runs?

Less than most sellers assume. Carma Developers (Cal.), Inc. v. Marathon Development California, Inc., 2 Cal. 4th 342 (1992), requires good faith when one party holds “a discretionary power affecting the rights of another” (at 372), but “implied terms should never be read to vary express terms” (at 374). If the agreement gives the buyer sole discretion over staffing or hours, using it usually is not a breach. I see that clause in most buyer-side first drafts.

The rule is sharper when the buyer makes payment impossible. In Pacific Venture Corp. v. Huey, 15 Cal. 2d 711, 717 (1940), buyers owing a $2,500 balance payable from mining royalties transferred the claims and still owed it, because “a person cannot avoid liability for the nonperformance of an obligation by placing such performance beyond his control.” Cal. Civ. Code § 1511 and § 1512 state a cousin of that rule. Delaware just tested how far that idea reaches.

What did the Delaware court decide in the Alexion earnout case?

Alexion bought Syntimmune in 2018 with up to $800 million in milestone payments and efforts measured against “biopharmaceutical companies similar in size and scope.” The September 5, 2024 liability opinion treated that as an objective test measured by a hypothetical comparable and held that killing the program, a decision “driven by AstraZeneca’s pursuit of merger synergies” after AstraZeneca bought Alexion, breached it. A sole-discretion clause did not help; it “was cabined by” the efforts promise.

The June 11, 2025 damages opinion awarded $180,944,915.32 plus interest, weighting each unpaid milestone by its probability (from Alexion’s own pre-breach estimates) and discounting to present value. The sellers sought every payment, about $755 million with interest, under the prevention doctrine, which the court held “does not provide a plaintiff a back door to damages in excess of proven expectation damages.”

Alexion later won about $12 million on an indemnification claim, and an August 3, 2026 letter cleared the way for final judgment. I find no Delaware Supreme Court decision as of mid-October 2026; any appeal would follow that judgment. Mid-2025 commentary predates all of this.

How would a California court value a lost earnout, and whose law applies?

Cal. Civ. Code § 3300 compensates “all the detriment proximately caused,” and § 3301 bars damages “not clearly ascertainable in both their nature and origin.” Sargon Enterprises, Inc. v. University of Southern California, 55 Cal. 4th 747 (2012), upheld excluding an expert’s market-share projections for a small dental implant company; lost profits “must also not be unduly speculative.” So the seller’s proof is the business’s own record. I expect California would land near Delaware’s answer, though I have found no published California earnout case on point.

Many deals pick Delaware law. Nedlloyd Lines B.V. v. Superior Court, 3 Cal. 4th 459, 466 (1992), enforces the choice if there is a substantial relationship or other reasonable basis, unless it offends a fundamental California policy and California has a materially greater interest. The implied covenant is no such policy. 6 Del. C. § 2708 presumes a Delaware choice reasonable in contracts of $100,000 or more. A Riverside seller who signs it should treat Alexion as the rulebook.

What should a seller insist on before signing an earnout?

First, define the effort. Alexion’s peer-company test took a trial to give it meaning. In a small deal I tie effort to the buyer’s conduct at similar locations, or to checkable numbers such as minimum office hours and a marketing budget. Then strike or narrow sole-discretion language, which under Carma can defeat the implied covenant.

Measure gross revenue or collections, not EBITDA, which moves whenever the buyer charges management fees or overhead to the location. The business should stay a separate reporting unit with unchanged accounting methods, and monthly reports plus an audit right let the seller’s accountant test the statement while objections still matter.

I also want acceleration if the buyer sells the business or fires the seller without cause; Alexion’s program died after its own buyer arrived. Calculation fights belong with an independent accountant on a short clock, effort fights in court. Follow notice clauses exactly, too; the Alexion sellers’ fee claim stalled for lack of a shown indemnification notice.

How are earnout payments taxed for a California seller?

Usually as installment sale proceeds. A sale whose price cannot be fixed by year-end is a contingent payment sale under IRC § 453 and Treas. Reg. § 15a.453-1(c). With a cap, basis is allocated as if every contingency is met; with only a fixed term, evenly over the term; with neither, over 15 years. Equipment recapture is taxed in the year of sale under § 453(i). Under IRC § 483 and Treas. Reg. § 1.483-4 (or § 1.1275-4(c) if § 1274 applies), each contingent payment is discounted to the sale date at the applicable federal rate, and the excess is ordinary interest.

If the earnout vanishes when the seller stops working there, the IRS can call it wages, and buyers may not object, since wages are deducted at once and goodwill over 15 years under IRC § 197. California adopts the installment rules through Cal. Rev. & Tax. Code § 17551 but taxes capital gain in the same 9.3 to 12.3 percent brackets as wages, plus 1 percent over $1 million (§ 17043). So the label barely moves California income tax; the swing is federal, plus payroll tax, including State Disability Insurance at 1.3 percent of all 2026 wages. For any real estate in the deal, § 18662(e) generally requires 3 1/3 percent withholding.

Illustrative numbers for the opening dentist, Dr. Ortiz: she closes in November 2026 for $1,000,000 plus $200,000 for each of 2027 and 2028 if collections reach $1.1 million. Say $100,000 of the closing cash goes to fully depreciated equipment and the rest to zero-basis goodwill. Her 2026 return shows $100,000 of ordinary recapture and $900,000 of capital gain. At an assumed 4 percent federal rate, the 2027 payment is about $192,300 of gain and $7,700 of interest; the 2028 payment, about $184,900 and $15,100.

As price, the $400,000 costs roughly $65,000 to $84,000 of federal income tax at 15 or 20 percent. As wages, about $140,000 to $148,000 at 35 to 37 percent, plus roughly $9,400 of Medicare tax and $5,200 of SDI at the 2026 rate, assuming her salary already tops the additional Medicare threshold and the Social Security wage base ($192,300 for 2027). California income tax, around $37,000 to $49,000, does not change. The label is worth roughly $80,000 to $90,000, so I tie the earnout to practice numbers, not to her staying.

What closing steps keep old tax debts from eating the earnout?

An unpaid earnout is the easiest money to hold back. Cal. Rev. & Tax. Code § 6811 requires a buyer to withhold enough of the price for the seller’s sales and use tax until CDTFA issues a receipt or certificate, and under § 6812 a buyer who skips it is liable up to the price. Cal. Unemp. Ins. Code §§ 1731 and 1732 work the same way for EDD. Inventory sellers and restaurants (most franchise food units and e-commerce brands) also face the bulk sale rules (Cal. Com. Code § 6103): notice 12 business days before closing under § 6105 and, at $2 million or less, payment of timely claims from the cash under § 6106.2. A dental practice usually falls outside them. Clear all of it before closing so the earnout is not later offset. (See my post on what a section 363 sale order does not cut off.)

Frequently Asked Questions

Is an earnout taxed at closing or when it is paid in California?

Usually when it is paid. California follows the federal installment rules, so gain on each payment is reported in the year it arrives, with part of it treated as interest.

Can a buyer close the business and owe nothing on the earnout?

Not if the contract has an effort clause, and California law also stops a party from escaping a payment by making its condition impossible. Expect the fight to be over the amount, usually the earnout’s realistic value rather than its face amount.

Does California give a lower tax rate on earnout gain?

No. California taxes capital gain at the same rates as wages, generally 9.3 to 12.3 percent at these income levels, plus 1 percent above $1 million, so the real difference is federal.

Should a California seller agree to Delaware law in the purchase agreement?

Usually California courts enforce the choice, and Delaware presumes it reasonable for contracts of $100,000 or more. A seller who accepts it should expect Delaware’s earnout cases to decide the dispute.

What happens to my earnout if the buyer sells the business?

Without an acceleration clause, it rides along and depends on how the next owner runs things. With one, the unpaid amount comes due at an agreed figure on a sale or a termination without cause.

How North Star Law Firm Can Help

North Star Law Firm represents California sellers and buyers in buying and selling a business, negotiates earnout terms through contract drafting and review, and models the tax through business sale tax structuring. Phillip Zagotti is a California attorney and a CPA, admitted to the U.S. Tax Court.

If a buyer has sent you an earnout term sheet, contact North Star Law Firm or schedule a consultation before the effort clause is final.

A treasurer at a small Inland Empire nonprofit finds $150,000 sent to an LLC the president owns. The memo says “loan,” and the one-page note bears his signature twice, for the charity and for his company. Nobody recalls a vote.

A September 24 opinion shows what that note can cost. In Jagannath v. Commissioner, T.C. Memo. 2026-92, a charity president owed $1,327,500 in excise taxes over $590,000 he never returned. That was a Tennessee charity. California law reaches the same transfer first, and the other directors with it.

Can a California nonprofit lend money to its president or a director?

Not without the Attorney General’s approval. Cal. Corp. Code § 5236(a) says a public benefit corporation “shall not make any loan of money or property to or guarantee the obligation of any director or officer, unless approved by the Attorney General.” The exceptions cover advances for reimbursable job expenses, secured life insurance premium arrangements, and a home loan the board deems necessary to keep an officer, secured by California real estate.

Under section 5237, directors who approve a prohibited loan are jointly and severally liable for the corporation’s loss, and abstaining at the meeting counts as approval. Routing the money through the president’s LLC does not clearly avoid section 5236, and section 5233 plainly reaches it.

When is a deal with a board member “self-dealing” in California?

Section 5233 reaches any transaction with the corporation in which a director “has a material financial interest,” unless the Attorney General or a court approves it (before or after closing) or a majority of directors in office, not counting the interested one, approves it in advance knowing the material facts, the deal is fair to the charity, and a reasonable investigation shows it could not do better.

Without clearance, the court can order the director to disgorge profits and restore losses “together with any income or appreciation lost,” with legal-rate interest and, for fraud, exemplary damages. The Attorney General can sue alone; the corporation, a director, an officer or a member suing derivatively (as in California LLC squeeze-outs) needs the Attorney General joined. Private suits generally have three years; the Attorney General has ten.

What did the Tax Court decide in Jagannath v. Commissioner?

In 2016 Sitaraman Jagannath was Senecura’s president; his father was a director and his daughter treasurer. That April, $590,000 left its money market account in an over-the-counter withdrawal. Eleven days later he signed an interest-free note as president of the lender and as owner of the borrower, his single-member LLC. The charity’s 2016 and 2017 returns listed the balance as a loan receivable from officers, with no Schedule L. Nothing was repaid.

The LLC’s statements showed no matching deposit, yet Judge Weiler found the transfer from the note, the returns and his control of the books. By trial he had dropped the loan defense and claimed a $600,000 wire that December repaid it, though Senecura reported that wire as a contribution from a donor he could not name. The burden stayed on him, because section 7491 does not reach excise taxes.

The court sustained $147,500 under section 4958(a)(1), $1,180,000 under section 4958(b), and section 6651(a)(1) and (2) additions for never filing Form 4720 or paying. The IRS had conceded the $20,000 manager tax before trial. Computations under Tax Court Rule 155 are due December 27, 2026, so no decision has been entered; any appeal goes to the Sixth Circuit.

How do the 25 percent and 200 percent excess benefit taxes work?

26 U.S.C. § 4958 taxes the insider, not the charity. A disqualified person is anyone with substantial influence in the prior five years, plus family and entities they own more than 35 percent of, and benefits provided “directly or indirectly” count (Treas. Reg. § 53.4958-4(a)(2)). The presumption of reasonableness in § 53.4958-6 needs advance approval by people without a conflict, comparability data and contemporaneous minutes. A note the insider signed on both sides fails at step one, as would his relatives’ approval.

The 25 percent tax attaches at once. The 200 percent tax follows unless the benefit is corrected before the IRS mails a deficiency notice or assesses. Correction under § 53.4958-7 means cash (not a new note) equal to the benefit plus interest compounded annually at no less than the applicable federal rate (AFR) for the month of the transfer.

Section 4961(a) abates the second-tier tax if correction comes within the correction period, which section 4963(e) runs to 90 days after the deficiency notice, extended while a Tax Court case blocks assessment. On my reading, Mr. Jagannath could still shed the 200 percent tax by repaying.

The insider files Form 4720 (Treas. Reg. § 53.6011-1(b)), due the 15th day of the fifth month after his tax year ends (§ 53.6071-1(f)). Yet the IRS’s three-year clock runs from the charity’s Form 990 for that year (section 6501(l)(1)), or six under section 6501(e)(3) if the return omits the tax without adequately disclosing the deal. Jagannath never mentions limitations.

What can the California Attorney General do about an insider loan?

Section 5250 opens a public benefit corporation to examination “at all times.” Gov. Code § 12588, part of the Supervision of Trustees and Fundraisers for Charitable Purposes Act (Gov. Code § 12580 et seq.), adds sworn testimony and production of the books. In court the office can seek an injunction, receiver or restitution under section 12591.1(f), recover fees under section 12598(b), or sue to remove a director under Corp. Code § 5223.

The usual trigger is the annual Form RRF-1, filed with the Form 990. Part B, Question 1 (Rev. 01/2024) asks about “contracts, loans, leases or other financial transactions” with an officer, director or trustee, “either directly or with an entity” they have an interest in, signed under penalty of perjury. The state exemption under R&TC § 23701d already bars private inurement, and the Franchise Tax Board can revoke it for not filing with the Registry (section 23703) or for a missed Form 199 (section 23777).

How would this play out for a Riverside youth sports nonprofit?

Illustrative facts: a Riverside youth soccer league has a $900,000 budget. On March 12, 2024, its president, a voting director, wires $150,000 to his property LLC as a “loan” nobody else signs. Two directors see it on a statement that summer and say nothing.

His first-tier tax is $37,500, and his Form 4720 was due May 15, 2025, so late-filing additions are accruing. Correcting on December 1, 2026, before any IRS contact, takes $150,000 plus interest at no less than March 2024’s short-term AFR of 4.71 percent (Rev. Rul. 2024-4), roughly $20,000, in cash. Waiting for a deficiency notice adds $300,000. The quiet directors are organization managers; if they meet the knowing test they share one $15,000 tax, and Treas. Reg. § 53.4958-1(d)(3) counts silence as participation when there is a duty to speak.

In California this is unapproved self-dealing the Attorney General can pursue until March 2034, and any director who voted for the “loan” would face section 5237. Under $2 million in revenue, the league needs no audit under Gov. Code § 12586(e), so RRF-1 Question 1 may be the first alarm. If the 2024 report said “no,” amend it.

What should a California board do after finding an insider transfer?

Stop payments, pull the bank records and hire counsel independent of the insider. I see the best results when the board demands correction in writing and the cash returns before anyone official asks. Then disclose, since Form 990 Part IV, lines 25a, 25b and 26, will ask about it anyway.

Next, adopt and enforce the conflict of interest policy Form 990 Part VI, line 12 asks about. Set pay with disinterested directors, outside data and same-day minutes; under $1 million in gross receipts, figures from three comparable local organizations suffice. Put it in the bylaws: no loans to directors or officers.

Frequently Asked Questions

Can a California nonprofit give its executive director a salary advance?

If the executive director is an officer, probably not without Attorney General approval. Section 5236 allows advances only for job expenses the corporation would otherwise reimburse, and a pay advance is a loan of money.

Does repaying the money make the 25 percent excise tax go away?

No. Timely repayment avoids or abates the 200 percent tax, but the 25 percent tax stays unless section 4962 applies. That requires reasonable cause, which is hard to show when the insider moved the money himself.

Are volunteer directors personally liable for an insider’s loan?

They can be. Knowing participation brings the 10 percent manager tax, capped at $20,000 per transaction, though relying on a reasoned written opinion from counsel or a CPA ordinarily defeats it.

Does the California RRF-1 really ask about loans to officers?

Yes. Part B, Question 1 asks about loans and other transactions with officers, directors and trustees, including through their entities. A yes answer needs an attachment with the terms and the authorizing board minutes.

What if the IRS has already mailed a deficiency notice?

Correcting within 90 days, or while a timely Tax Court case is pending, can still get the second-tier tax abated under sections 4961 and 4963(e). Petition on time and have the correction amount calculated immediately.

How North Star Law Firm Can Help

North Star Law Firm drafts nonprofit bylaws and conflict rules through its entity formation and governance agreement work and represents insiders and managers before the IRS and Tax Court through its tax defense practice. Phillip Zagotti is a California attorney and a CPA admitted to the U.S. Tax Court.

If your board found an insider transfer, contact North Star Law Firm or schedule a consultation before the next Form 990 or RRF-1 is signed.

Escrow on a Murrieta house is two weeks from closing when the title officer calls. An abstract of judgment is recorded against the seller, from a Riverside County case brought by a former supplier of her tile company. The default was entered in 2017. Nobody remembers a summons.

Is it too late? In 2026 that depends on the court. The nation’s highest court tightened the federal rule in January; California’s Supreme Court loosened the state rule in late 2024.

Why do California companies end up with default judgments they never knew about?

Usually the papers went where state records pointed. A corporation is served through its designated agent or an officer under Cal. Code Civ. Proc. § 416.10, and it names that agent on the annual statement required by Cal. Corp. Code § 1502. LLCs file every two years under section 17702.09, and section 17701.16(b) says a new agent address is not “effective until” the statement is amended.

If the server cannot find the agent at the listed address, the court can order service on the Secretary of State under Corp. Code § 1702(a) (section 17701.16(c) for LLCs). That office then mails the papers to whatever principal office its records show. The most common cause of a surprise judgment I see is a registered-agent address nobody updated after the business moved.

How does an old default judgment surface, and how long can a creditor enforce it in California?

Late, through a bank levy, a garnished paycheck or a title report. Recording an abstract of judgment creates a real property lien under Code Civ. Proc. § 697.310 that lasts until ten years from entry of the judgment, not from recording. The abstract must show where the summons was served or mailed (§ 674(a)(3)), often the first clue.

A money judgment is enforceable for ten years (§ 683.020), renewable for ten more by an application filed before that period ends (§§ 683.120, 683.130), and a recorded renewal extends the lien (§ 683.180). Interest runs at 10 percent under section 685.010; the 5 percent rate added in 2023 covers certain medical and consumer judgments, not business debts.

Is a California default judgment void if the company was never properly served?

Often. A default entered without statutory service “is void,” said Dill v. Berquist Construction Co., 24 Cal. App. 4th 1426, 1444 (1994), quoted in California Capital Ins. Co. v. Hoehn, 17 Cal. 5th 207 (2024).

Void on its face means the defect appears in the judgment roll, the default file itself (§ 670(a)), with no outside evidence. A proof of service under section 415.20(a) reciting no mailing is, in my reading, facially defective. A regular-looking proof naming a “person in charge” at a suite you had already left is void only once a lease and declarations prove the move. Most business cases are that second kind, and a proper section 1702 order may mean no defect at all.

How late is too late to set aside a default judgment in California state court?

Section 473(b) covers excusable neglect, “in no case exceeding six months.” Section 473.5 helps a validly served defendant who got no actual notice: file by the earlier of two years after entry or 180 days after written notice, swearing the lapse “was not caused by the party’s avoidance of service or inexcusable neglect.”

Section 473(d) reaches “any void judgment.” Facially void ones were always open to attack. For the rest, Rogers v. Silverman, 216 Cal. App. 3d 1114 (1989), and cases such as Trackman v. Kenney, 187 Cal. App. 4th 175 (2010), borrowed a two-year cap. Hoehn ended that. On a 2011 Placer County default the defendant said he first learned of through a 2020 wage garnishment, the Court held that “a section 473(d) motion to vacate a judgment that is void for lack of proper service is not subject to the judicially imposed two-year limitation,” disapproving Rogers “and its progeny.” Footnote 11 left open whether diligence after discovery is required; Kramer v. Traditional Escrow, Inc., 56 Cal. App. 5th 13, 37 (2020), measures it “from when a party discovers the default.” Hoehn moved within three months.

AB 747 (Stats. 2025, ch. 563) adds section 473.2 on January 1, 2027, making the plaintiff prove lawful service “by a preponderance of the evidence,” but AB 2042 (Stats. 2026, ch. 379) limits it to service attempted or completed from that date on. For a 2017 judgment, Evid. Code § 647 still presumes a registered server’s return accurate until you produce contrary evidence.

What did the Supreme Court decide in Coney Island, and does it reach federal judgments in California?

On January 20, 2026, a unanimous Court affirmed the Sixth Circuit in Coney Island Auto Parts Unlimited, Inc. v. Burton, No. 24-808, a bankruptcy default attacked only after a 2021 seizure. Justice Alito wrote: “We hold that this time limit applies to a motion alleging that a judgment is void.” Rule 60(c)(1)‘s reasonable-time requirement now governs voidness motions in federal court. Justice Sotomayor concurred only in the judgment.

The holding is narrow. The Court expressed “no view” on whether the service voided the judgment, left a reasonable time undefined, and reserved Rule 60(d) independent actions. It added that “it might be reasonable for a defendant not to seek relief before learning about a plaintiff’s attempted enforcement.” There was no remand.

This displaces Ninth Circuit law. Meadows v. Dominican Republic, 817 F.2d 517 (9th Cir. 1987), said “[t]here is no time limit on a Rule 60(b)(4) motion,” and SEC v. Internet Solutions for Business Inc., 509 F.3d 1161 (9th Cir. 2007), agreed, while holding that a defendant who knew of the suit must prove non-service and can overcome a signed return only by “strong and convincing evidence.” Through Fed. R. Bankr. P. 9024, the limit reaches bankruptcy court defaults too (creditors facing a filing should see my post on judgment creditors in Chapter 11). One irony: Hoehn’s footnote 10 leaned on the federal rule having no time limit. Expect creditors to cite Coney Island when pressing for a diligence rule.

What should a Murrieta owner do when escrow turns up a 2017 Riverside County judgment?

An illustrative case. Dana’s tile corporation moved from Riverside to Temecula in 2015 without updating its statement of information. In 2016 a supplier sued the company and Dana, as guarantor, in Riverside County Superior Court, serving the company through the Secretary of State and Dana by substituted service at the old suite. A $48,000 default was entered against both on March 14, 2017.

At 10 percent simple interest that is about $13.15 a day, roughly $46,000 by October 16, 2026 (payoff near $94,000 before costs). Enforceability ends in March 2027 unless renewed, and section 683.170 gives Dana 60 days after service of a renewal notice to challenge it.

The company’s realistic remedy was section 473.5, which closed in 2019. Dana has a Hoehn motion if she proves the suite was no longer her place of business and that no diligent personal-delivery attempts came first, as section 415.20(b) requires. Otherwise she can negotiate a payoff with escrow holding the disputed sum, or consider bankruptcy, where 11 U.S.C. § 522(f)(1)(A) lets a debtor avoid a judicial lien that impairs an exemption.

The week a judgment appears, I order the court file and read the proof of service line by line, then gather the Secretary of State history, the lease and declarations from whoever occupied the old suite. Each week after discovery is one a creditor will call unreasonable.

Frequently Asked Questions

Can a California default judgment be set aside after two years?

Yes, if improper service made it void. California Capital Ins. Co. v. Hoehn held that a section 473(d) motion is not subject to the two-year cap courts had borrowed from section 473.5. If you were validly served but never saw the papers, the section 473.5 deadlines still apply.

Does Coney Island apply to California superior court judgments?

No. It interprets Federal Rule of Civil Procedure 60, so it governs federal district and bankruptcy court judgments. State judgments fall under the Code of Civil Procedure and Hoehn.

What if the summons was served on the California Secretary of State?

Court-ordered service there is valid if the plaintiff could not find your agent with reasonable diligence. The papers go to the principal office on file, so an outdated address means you may never see them, and the usual remedy is a section 473.5 motion.

How long does a judgment lien last on a California home?

Until ten years from the date the judgment was entered. If the creditor renews and records the renewal before the lien expires, it runs ten years from the renewal application.

Will the new SPARE Act help with an old judgment?

Probably not directly. AB 2042 limits the burden-shifting procedure in section 473.2 to service attempted or completed on or after January 1, 2027. Older judgments are decided under current law and Hoehn.

How North Star Law Firm Can Help

North Star Law Firm brings motions to vacate surprise judgments through its business and contract law practice, keeps agent records current through entity formation work, and handles cases where bankruptcy fits better. Phillip Zagotti is a California attorney and a CPA admitted to the U.S. District and Bankruptcy Courts for the Central District of California.

If a levy or title report just surfaced a surprise judgment, contact North Star Law Firm or schedule a consultation before the creditor renews it.

You own 25 percent of a California LLC. The two managing members now pay themselves large “management fees” and have stopped distributions, yet your K-1 still reports profit. You sue. Weeks later the LLC files Chapter 11, and you are told most of your case now belongs to the bankruptcy estate.

The Second Circuit sorted a New York LLC member’s claims this way in Little Hearts Marks Family II L.P. v. Carter (In re 305 East 61st Street Group LLC), 130 F.4th 272 (2d Cir. 2025), borrowing Delaware’s test. California has its own test, and Ninth Circuit bankruptcy law decides what survives.

Which claims belong to me personally as a member of a California LLC?

Under Jones v. H.F. Ahmanson & Co., 1 Cal. 3d 93 (1969), a claim is derivative when its gravamen is injury to the company, or when it seeks to recover or protect company assets. You may sue individually when your injury is not incidental to an injury to the company.

Schuster v. Gardner, 127 Cal. App. 4th 305 (2005), lists suits to compel declared or mandatory payouts and to enforce voting rights as typical direct actions. Unless the operating agreement says otherwise, Cal. Corp. Code § 17704.07(c)(4) requires all members’ consent before a manager-managed LLC sells substantially all its property or acts outside the ordinary course. A refused records request under section 17704.10 is direct, as is fraud that induced your investment. Stopped distributions are harder: section 17704.04(b) creates no right to one unless the company decides to pay.

Why do most squeeze-out complaints belong to the LLC instead?

Because the money left the company’s account, not yours. In PacLink Communications International, Inc. v. Superior Court, 90 Cal. App. 4th 958 (2001), insiders allegedly moved an LLC’s assets into new entities. The members’ claims were derivative, since they owned no interest in specific LLC property and their loss was “essentially a diminution in the value of their membership interest.”

Schrage v. Schrage, 69 Cal. App. 5th 126 (2021), is the cautionary case. A one-third owner of a family business group that included several LLCs lost his fiduciary duty judgment against his brothers on appeal. The claim was derivative, and his damages (the group’s loss divided by three) proved it. The court refused to exempt closely held companies and doubted Jara v. Suprema Meats, Inc., 121 Cal. App. 4th 1238 (2004), which treated excessive pay used as a disguised distribution as a direct claim.

Derivative suits must follow Cal. Corp. Code § 17709.02: membership when the wrong occurred, a particularized demand on the managers (or the reasons you made none), and written notice to the company. Defendants may seek a bond of up to $50,000. Under Sirott v. Superior Court, No. A164037 (Cal. Ct. App. May 5, 2022), you must also stay a member until the case ends.

Can I force a buyout or dissolution of a California LLC?

Any member, regardless of percentage, may sue under Cal. Corp. Code § 17707.03 when, among other grounds, management is deadlocked or subject to internal dissension or those in control have engaged in “persistent and pervasive fraud, mismanagement, or abuse of authority.” Section 17701.10(c)(7) bars the operating agreement from removing that remedy.

The others can avoid dissolution by buying you out for cash at fair market value. A disputed price goes to three court-appointed appraisers, usually valued as of your filing date. I find a dissolution petition starts buyout talks faster than any damages count. Expulsion needs an agreement clause, narrow unanimous-vote grounds, or a court order under section 17706.02.

What happens to my lawsuit when the managers put the LLC into Chapter 11?

The LLC’s own claims become estate property under 11 U.S.C. § 541(a)(1). Estate of Spirtos v. One San Bernardino County Superior Court Case Numbered SPR 02211, 443 F.3d 1172 (9th Cir. 2006), gives the trustee the exclusive right to sue for the estate, and section 1107(a) hands that power to a debtor in possession. So the managers you sued now control your derivative claims. Ahcom, Ltd. v. Smeding, 623 F.3d 1248 (9th Cir. 2010), lets state law decide which claims are the estate’s. It found no general alter ego claim belonging to a California company and rejected CBS, Inc. v. Folks (In re Folks), 211 B.R. 378 (B.A.P. 9th Cir. 1997), so a member who is also an LLC creditor may keep alter ego theories for herself.

The automatic stay halts suits against the LLC, but In re Chugach Forest Products, Inc., 23 F.3d 241 (9th Cir. 1994), holds it generally does not protect non-debtors such as the managers personally. Claims against the LLC face section 510(b) subordination. In In re Tristar Esperanza Properties, LLC, 782 F.3d 492 (9th Cir. 2015), a California LLC member’s judgment for her buyout price was subordinated anyway.

What can a minority member still do inside the bankruptcy case?

As an equity security holder, you may be heard on any issue under 11 U.S.C. § 1109(b). Price v. Gurney, 324 U.S. 100 (1945), requires dismissal of a petition filed without authority under state law. If your operating agreement is silent, section 17704.07(c)(4)(B) arguably required your consent.

In re Marsch, 36 F.3d 825 (9th Cir. 1994), upheld dismissal under section 1112(b) of a petition filed to head off a state court judgment. Otherwise, section 1104(a)(1) requires a trustee for fraud, dishonesty or gross mismanagement, before or after filing. A trustee can sue the managers or sell the claims under section 363(b), and you can bid. Bankruptcy Rule 2004 examinations can stand in for the stayed records suit.

How would this sort out for a three-member logistics LLC in Ontario?

In this illustrative case, Maya paid $250,000 in 2021 for 25 percent of a manager-managed trucking and warehousing LLC in Ontario; Ray and Tom manage it and split the rest. In 2025 they raised their fees from $150,000 to $420,000 apiece and stopped distributions. The LLC still reported $640,000 of taxable income, so Maya’s K-1 shows $160,000 with no cash. Her February 2026 records request goes unanswered. She sues in San Bernardino County Superior Court in April; the LLC files Chapter 11 in June.

The $540,000 of added fees is a derivative claim held by an estate Ray and Tom run; measuring her harm as 25 percent of it ($135,000) is exactly what sank the plaintiff in Schrage. Her records claim is direct but stayed as to the LLC. A fraud claim about her 2021 investment, aimed at Ray and Tom personally, keeps going. Her leverage is a dismissal or trustee motion, plus an offer to buy the fee claims.

As a CPA, I see the tax side hurt most. A multi-member LLC is a partnership by default, so 26 U.S.C. § 702(a) taxes Maya’s share whether or not cash arrives (the S corporation version is similar). Section 705(a) adds the $160,000 to her basis, so a later buyout is not taxed twice. Section 17704.10 entitles her to the returns, with tax information due within 90 days after year-end. If Ray and Tom buy her out, a section 754 election can give them an inside basis step-up worth pricing in. And if the plan cancels LLC debt, section 108(d)(6) tests the bankruptcy exclusion at the member level, so Maya may report cancellation income she cannot exclude that way.

What should a minority member negotiate into a California operating agreement?

Mandatory tax distributions first, subject to the solvency limits in section 17704.05. Then a cap on manager pay, or approval of related-party payments by the members not receiving them. Section 17701.10 lets the agreement define what is not disloyal but not eliminate the duty of loyalty in section 17704.09. Monthly financials should supplement the unwaivable statutory inspection right, usually my first pressure point. Add tag-along and put rights and a deadlock procedure. The clause I most often find missing is one requiring your consent to any bankruptcy filing.

Frequently Asked Questions

Can I sue the managers of my California LLC in my own name?

Only for an injury that is not incidental to the company’s injury, such as breach of your own rights under the operating agreement. Claims that company money was wasted or diverted are usually derivative, with their own procedure.

Does the LLC’s bankruptcy stop my lawsuit?

It stops claims against the LLC, and derivative claims pass to the estate. Direct claims against the managers personally generally continue, though the debtor may ask the court to extend protection.

Can I still get a buyout if the LLC is in Chapter 11?

Not through the state dissolution case while the stay lasts. If the bankruptcy is dismissed, your dissolution claim and the buyout election under section 17707.03 return. Inside the case, a claim for your interest’s value is likely subordinated.

Why do I owe tax on LLC income I never received?

A multi-member LLC is usually taxed as a partnership, so members report their share of income even without cash. That income raises your basis, so it is not taxed twice. A mandatory tax distribution clause is the usual fix.

How do I get my LLC’s tax returns and books?

Make a written request under Corporations Code section 17704.10. The operating agreement cannot waive those rights, and a court may award attorney’s fees when a refusal was unjustified.

How North Star Law Firm Can Help

North Star Law Firm advises California LLC members on operating and shareholder agreements, from entity formation through disputes, and handles the bankruptcy side when the company files. Phillip Zagotti is a California attorney and a CPA, admitted to the U.S. Bankruptcy Court for the Central District of California.

If you are being squeezed out of a California LLC, contact North Star Law Firm or schedule a consultation.

Two partners in Rancho Cucamonga run a marketing agency billing about $600,000 a year. Every national article they read on entity choice says roughly the same thing: a C corporation if you will raise venture money, otherwise an LLC or an S corporation. None mentions what California charges for each, or that a Wyoming LLC will not change the bill.

For an Inland Empire business that will live its whole life here, the state layer is often the bigger number.

How much does California tax an LLC, S corporation or C corporation each year?

Every one of them owes at least $800. An LLC pays an annual tax under Cal. Rev. & Tax. Code § 17941 equal to the corporate minimum in section 23153, owed until it cancels, active or not. A corporation pays the greater of $800 or a tax on net income: 8.84 percent under section 23151, or 1.5 percent for an S corporation under section 23802.

The LLC also pays a fee under section 17942 measured by total California income, meaning gross income plus cost of goods sold. Profit is irrelevant. The fee is $900 from $250,000, $2,500 from $500,000, $6,000 from $1 million, and $11,790 at $5 million. An LLC that loses money on $1.2 million of receipts still owes $6,000.

Under section 23153(f), a new corporation skips the minimum tax in its first year, though an S corporation still pays 1.5 percent on first-year income. The LLC first-year exemption for 2021 through 2023 has expired. SB 122, signed June 29, 2026, added section 17941(g)(2), setting the first-year LLC tax at $400 for taxable years beginning in 2027 through 2029. The same $800 follows a rental house held in an LLC, as I discussed in the post on LLCs and trusts for rental property.

Watch year-end dates. Under section 23114, a corporation with a taxable year of 15 days or less and no business in it owes nothing for that stub, and the FTB’s Form 568 instructions give LLCs a matching rule. An LLC organized in mid-December 2026 that opens immediately owes $800 for 2026 and misses the $400 rate.

How do the numbers compare for a $600,000 business in Rancho Cucamonga?

Illustratively, give the agency two equal owners and put it in its third year. All $600,000 of revenue comes from California clients, and staff, rent and software cost $240,000, leaving $360,000 before the owners are paid.

As an LLC taxed as a partnership, the company owes $800 plus a $2,500 fee, $3,300 in all, and each owner reports $180,000. As an S corporation paying each owner $100,000, with an assumed $16,000 of employer payroll taxes, net income is $144,000 and the 1.5 percent tax is $2,160, with no fee.

As a C corporation with the same salaries, California takes 8.84 percent of $144,000, about $12,730, before the 21 percent federal rate in 26 U.S.C. § 11(b), and any later dividend is taxed again to the owners. The S corporation comes out about $10,570 ahead of the C corporation. Its edge over the LLC grows in a bad year, when it owes only $800 while the LLC still pays a fee on gross receipts.

Can a doctor, dentist, lawyer or CPA practice through a California LLC?

No. Cal. Corp. Code § 17701.04(e) bars an LLC from rendering professional services here, as Corp. Code § 13401(a) defines them: services lawful only under a license authorized by the Business and Professions Code, the Chiropractic Act or the Osteopathic Act. A checklist steering a Riverside dental practice toward an LLC recommends something California forbids.

The usual answer is a professional corporation under the Moscone-Knox Professional Corporation Act, Corp. Code § 13400 et seq., whose shares go only to licensed persons under section 13406(a). It can elect S status, paying 1.5 percent and the $800 minimum with no fee. Lawyers, accountants and a few design professions may also use a registered limited liability partnership under Corp. Code § 16101, which owes $800 under Rev. & Tax. Code § 17948 but no fee.

What rules govern a California LLC that never signed an operating agreement?

The Revised Uniform Limited Liability Company Act, Corp. Code § 17701.01 et seq., fills the gaps. Each member owes the loyalty and care duties in section 17704.09, changeable only in a written agreement with informed consent. Under section 17704.04, profits and distributions follow the recorded value of contributions, so partners who split the work evenly but recorded only one partner’s $50,000 have a lopsided default.

A member may withdraw at any time under section 17706.01, and without a written buyout term keeps only a transferee’s right to future distributions. A member’s personal creditor gets a charging order, the exclusive remedy under section 17705.03(f). Section 17707.03(c) gives the others a buyout right in a dissolution suit.

A corporation runs on bylaws, minutes and a board under Corp. Code § 300(a). With 35 or fewer shareholders it can elect close corporation status under section 158 and operate by shareholders’ agreement under section 300(b), and section 2000 offers its own buyout. Done properly, neither form is light on paper; the LLC’s risk is that its defaults run silently.

Will a Wyoming or Delaware LLC avoid California’s $800 tax?

No. Section 17941 reaches any LLC doing business here under section 23101, wherever formed, and a company run from California is commercially domiciled here under section 23101(b)(1), with no dollar test. The thresholds matter for outside companies with a small footprint. The FTB’s 2025 figures were $757,070 of California sales or $75,707 of property or payroll, or 25 percent of the total. The FTB had not posted 2026 amounts when I checked in October 2026.

The foreign LLC must also register under Corp. Code § 17708.02. Until it does, section 17708.07(a) bars it from suing in California, and the FTB describes a $2,000 penalty for doing business unregistered. The owner pays two states. A passive investor is different: in Swart Enterprises, Inc. v. Franchise Tax Board, 7 Cal. App. 5th 497 (2017), a 0.2 percent member of a manager-managed LLC was not doing business here. Not so for an owner working in Ontario.

When does an S election save California owners money?

The savings are mostly federal. A working LLC member generally pays self-employment tax under 26 U.S.C. § 1401 on the whole share, while an S corporation owner pays payroll tax only on wages. The IRS requires reasonable compensation first and looks at how much revenue the owner’s own services produce. My $100,000 salaries are an assumption; if the owners personally generate most of the revenue, the IRS could push higher.

California taxes wages, profit shares, dividends and gains alike as ordinary income, up to 12.3 percent plus the 1 percent tax over $1 million in section 17043, or 13.3 percent. The 3.8 percent tax in 26 U.S.C. § 1411 is federal and generally hits business income only for passive owners.

The PTE elective tax under section 19900 lets a partnership-taxed LLC or an S corporation pay 9.3 percent at the entity level, deduct it federally as IRS Notice 2020-75 permits, and pass a credit to owners. After SB 132 the FTB lists it through 2030, and from 2026 a missed June 15 prepayment cuts the credit by 12.5 percent instead of voiding the election. With the cap in 26 U.S.C. § 164(b)(6) at $40,400 for 2026, phasing down above $505,000 of income, owners at $180,000 may gain little from it.

Is the C corporation QSBS exclusion worth anything in California?

Only federally. Rev. & Tax. Code § 18152 says 26 U.S.C. § 1202 does not apply in California. The state’s own version, former section 18152.5, required 80 percent of assets and payroll in California; Cutler v. Franchise Tax Board, 208 Cal. App. 4th 1247 (2012), held that requirement unconstitutional as applied to the companion deferral rule. AB 1412 (2013) granted partial relief for 2008 to 2012 sales and let the section lapse January 1, 2016. Friday’s post covers QSBS gifting.

Frequently Asked Questions

Do I owe California’s $800 tax if my LLC made no money?

Yes. A California-organized or registered LLC owes the annual tax every year until it cancels, even with no income. The separate fee starts at $250,000 of California income. For a first taxable year beginning in 2027 through 2029, the tax is $400.

Is an S corporation cheaper than an LLC in California?

Often, because 1.5 percent of net income can be less than $800 plus the receipts fee. In exchange you run payroll, pay each working owner a reasonable salary, and live within federal limits such as one class of stock.

Can my California LLC be taxed as an S corporation?

Yes. California follows the federal election, so the LLC files Form 100S, pays 1.5 percent with an $800 minimum, and drops the LLC fee. The LLC act still governs its internal affairs, so the operating agreement still matters.

If I form my LLC in Wyoming, do I still owe California tax?

If you run it from California, yes. It is commercially domiciled and doing business here, so it must register and pay the $800 tax and any fee, on top of Wyoming’s own charges.

Does California allow the federal QSBS exclusion?

No. Section 18152 turns off section 1202 for California, and the state’s own version lapsed after the Cutler decision. The federal exclusion may still apply, but California taxes the whole gain at rates up to 13.3 percent.

How North Star Law Firm Can Help

North Star Law Firm sets up California companies through its entity formation practice and models the state and federal numbers through entity selection and S corporation planning. Since the statutory defaults decide whatever nobody writes down, it also drafts operating and shareholder agreements. Phillip Zagotti is a California attorney and a CPA, admitted to the U.S. Tax Court.

Before you form or restructure a company, contact North Star Law Firm or schedule a consultation.

The call usually starts with a Schedule K-1. A minority owner of a California S corporation sees a six-figure share of the company’s profit allocated to him, and he has not received a dollar of it. The owners who run the company have been paying themselves and keeping him away from the books. He still owes federal and California tax on his share.

Two August 2026 rulings bear on his position. The Ninth Circuit’s affirmance in Maggard limits his tax arguments, and the Eleventh Circuit’s Owoc decision matters if the company ends up in bankruptcy.

Why does an S corporation shareholder owe tax on money he never received?

Under 26 U.S.C. § 1366(a), each shareholder reports his pro rata share of the corporation’s income, cash or no cash. Quoting Moore v. United States, 602 U.S. 572 (2024), the Ninth Circuit’s Maggard disposition said shareholders are taxed “even if the entity has not distributed any money or property to them.” The company owes him a K-1 under 26 U.S.C. § 6037(b), but nothing obliges the insiders to send cash for the tax. That gap is phantom income.

Can lopsided distributions end the S election?

A shut-out owner often argues the insiders now hold a better class of stock, which 26 U.S.C. § 1361(b)(1)(D) forbids. Maggard v. Commissioner, T.C. Memo. 2024-77, rejected that theory. James Maggard owned 40 percent of Schricker Engineering Group, an engineering company in California, while the other owners took outsized distributions and froze him out. Judge Holmes held the S election survived for 2014 through 2016. Under Treas. Reg. § 1.1361-1(l)(2)(i), identical rights are judged by the “governing provisions” (articles, bylaws, state law and binding agreements), and distributions that differ in timing or amount do not create a second class.

The Ninth Circuit affirmed in Maggard v. Commissioner, No. 25-4131 (9th Cir. Aug. 26, 2026), an unpublished memorandum that is not precedent except as Ninth Circuit Rule 36-3 allows. It is brief, but it comes from the court that hears California’s Tax Court appeals. Termination is not a lever here; the fix has to come from corporate law.

How does California tax the same income?

California follows the federal election under Cal. Rev. & Tax. Code § 23800 and section 23801(a) but still taxes the entity. Section 23802 imposes a 1.5 percent tax on the S corporation’s net income and keeps the $800 minimum franchise tax of section 23153. The company files Form 100S and gives each owner a Schedule K-1 (100S). Section 17087.5 carries Subchapter S into the personal income tax, and section 17041(a) taxes a resident’s entire taxable income, so an owner in Rancho Cucamonga or Elk Grove pays California tax on his whole share. (An earlier post looks at how California taxed one S corporation’s division sale.)

What does this look like for a 30 percent owner in Fontana?

In an illustrative case, Dan owns 30 percent of a Fontana trucking company organized as a California S corporation, and two brothers own the rest and run it. In 2025 the company earns $900,000. The brothers take $560,000 in distributions, which means Dan’s pro rata share would have been $240,000. He gets nothing.

Each of Dan’s K-1s shows $270,000. At an assumed combined federal and California rate of 35 percent, he owes about $94,500, while the company pays $13,500 of California tax at 1.5 percent. Under 26 U.S.C. § 1367(a)(1), his basis rises by $270,000 with no distributions to reduce it, taking him from $50,000 to $320,000.

What can a frozen-out shareholder do under the California Corporations Code?

Start with records. Cal. Corp. Code § 1601 lets any shareholder inspect the books, records and minutes on written demand for a purpose tied to his shareholder interests, and the bylaws cannot restrict it. Section 1501(c) lets a 5 percent holder demand interim financial statements. Those are the records I test a K-1 against.

In Jones v. H.F. Ahmanson & Co., 1 Cal. 3d 93 (1969), the California Supreme Court held that controlling shareholders may not use their power “to benefit themselves alone or in a manner detrimental to the minority.” Uneven distributions can support a direct claim for Dan’s loss. Harm to the company, like inflated insider pay, goes derivatively under Corp. Code § 800, which requires a pleaded demand on the board or a reason for skipping it.

Section 1800(b)(4) permits involuntary dissolution for persistent and pervasive fraud, mismanagement or abuse of authority, or persistent unfairness toward shareholders, and section 1800(b)(5) adds a ground for corporations with 35 or fewer shareholders when liquidation is reasonably necessary to protect the complaining owner. Standing normally takes 33 1/3 percent, but section 1800(a)(2) leaves out shares of anyone who personally took part in the (b)(4) conduct, so if both brothers did, Dan holds every share that counts. Under Corp. Code § 2000, the company or the 50 percent holders can avoid dissolution by buying his shares at fair value, usually as of the filing date, with court-appointed appraisers if the sides disagree.

What should a California shareholder agreement say about taxes?

Most of this is preventable. A shareholder agreement should require a yearly tax distribution, paid before estimated tax deadlines, equal to allocated income times one assumed rate, per share to every owner. Treating every share alike keeps it within the governing-provisions test; paying some owners more per share would invite the second-class problem. I also add a put right if tax distributions are missed and a deadlock clause that ends in a buy-sell. The firm drafts these in its shareholder agreement and S corporation planning work.

What happens to the S election if the corporation files bankruptcy?

When a Chapter 7 trustee sells fully depreciated trucks, the gain passes through to shareholders while creditors get the cash. The fix is revocation. Under 26 U.S.C. § 1362(d)(1)(B), that takes consent from holders of “more than one-half of the shares,” and Treas. Reg. § 1.1362-6(a)(3) has the corporation file the statement. A revocation filed by the 15th day of the third month of the year relates back to January 1.

In re Majestic Star Casino, LLC, 716 F.3d 736 (3d Cir. 2013), held that pass-through status is not estate property, and Owoc v. Liquidating Trustee, No. 24-14048 (11th Cir. Aug. 10, 2026), agreed, reasoning that the election is controlled by the shareholders rather than the company.

California is different. In Parker v. Saunders (In re Bakersfield Westar, Inc.), 226 B.R. 227 (B.A.P. 9th Cir. 1998), the owners of a California ambulance company revoked its election about a month before bankruptcy. The Ninth Circuit Bankruptcy Appellate Panel held that the right to revoke was the corporation’s property and that the trustee could avoid the revocation under 11 U.S.C. § 548. Majestic Star criticized that reasoning, but I have found no Ninth Circuit decision resolving the conflict.

So here, revoking before filing invites a fraudulent transfer claim, and revoking after invites a stay fight. Document majority consent and, once a case is open, ask the bankruptcy court for an order before the statement goes in, as Owoc did. Dan cannot revoke alone. The brothers, though, now bear 70 percent of the phantom gain and may well cooperate.

How should a shareholder read the K-1 and handle tax he cannot pay?

As a CPA, I reconcile the K-1 to the money. If it shows distributions he never received or income the financials do not support, he can report what he believes is right and flag the difference on IRS Form 8082, as section 6037(c) allows.

If the company fails, Dan’s $320,000 basis becomes a worthless-stock loss under 26 U.S.C. § 165(g). That is a capital loss, and section 1211(b) limits its yearly use to capital gains plus $3,000 unless qualifying stock lets section 1244 treat up to $50,000 a year ($100,000 joint) as ordinary.

For California tax he cannot pay, R&TC § 19008(b) requires the FTB to grant an installment agreement on $25,000 or less of tax, payable within five years, if he has filed his returns and cannot pay in full. Larger balances go through the FTB’s installment agreement or offer in compromise programs, and the FTB says it delays collection during temporary hardship.

Frequently Asked Questions

Do I have to pay tax on S corporation income I never received?

Yes. Federal law taxes each shareholder on his pro rata share of S corporation income whether or not it is distributed, and California taxes residents on the same share. The undistributed income does raise your stock basis. The fix is to pursue the missing distributions under corporate law and arrange payment with the IRS and FTB.

Does an S corporation lose its status if the other owners take bigger distributions?

Generally no. In Maggard v. Commissioner, the Tax Court ruled that unequal distributions do not violate the single-class rule when the articles, bylaws and binding agreements give every share identical rights, and the Ninth Circuit affirmed in an unpublished August 2026 memorandum. The distributions can still support a fiduciary duty claim.

Can a 30 percent shareholder sue to dissolve a California corporation?

Possibly. Corporations Code section 1800 generally requires holders of 33 1/3 percent to sue, but shares held by people who personally took part in the alleged misconduct are not counted. If the controlling owners are the wrongdoers, a 30 percent owner may qualify, though the company can usually buy him out at fair value instead.

Does California tax S corporation income twice?

Partly. The corporation pays a 1.5 percent tax on its net income, subject to the $800 minimum franchise tax, and files Form 100S. Each resident shareholder also pays personal income tax on his full Schedule K-1 (100S) share. That is less than C corporation double taxation, but federal law has no similar entity tax.

Can shareholders revoke the S election after the company files bankruptcy?

The Third and Eleventh Circuits allow it because shareholders, not the estate, control the election. California is less settled because a 1998 Ninth Circuit Bankruptcy Appellate Panel decision let a trustee attack a revocation as a transfer of the corporation’s property. Revocation needs majority shareholder consent, and a bankruptcy court order first is prudent.

How North Star Law Firm Can Help

North Star Law Firm represents minority owners and closely held companies across California, including the Inland Empire and the Sacramento area, in shareholder disputes, buyouts and the tax fallout that comes with them. The firm reviews and drafts shareholder agreements, advises on S corporation elections and revocations, works out installment agreements with the IRS and FTB, and counsels owners whose companies are headed into Chapter 7 or Chapter 11. Phillip Zagotti is a California attorney and a CPA, admitted to the U.S. Bankruptcy Court for the Central District of California, and he represents taxpayers before the IRS, the Franchise Tax Board, the Office of Tax Appeals and the U.S. Tax Court.

If you are paying tax on profits you are not receiving, contact North Star Law Firm or schedule a consultation.

Picture a buyer’s lawyer emailing a 24-page stock purchase agreement on a Friday and asking for a signature by Monday. The price line reads “$1.00 and other good and valuable consideration.” A two-year noncompete starts at closing, and one exhibit the text relies on is missing. A South Dakota snack company owner signed something similar, filed Chapter 11, and was allowed to reject it in In re Dandurand, No. 24-40401 (Bankr. D.S.D. May 23, 2025). On August 10, 2026 the Eighth Circuit Bankruptcy Appellate Panel affirmed in Kanyon Holdings, LLC v. Dandurand (In re Dandurand), No. 25-6010 (B.A.P. 8th Cir. Aug. 10, 2026).

That case ran on South Dakota law. California’s rulebook differs, and in several places it is harder on a buyer who drafts loosely.

How does a California court read a purchase agreement that does not make sense?

The court looks for what both sides intended when they signed under Cal. Civ. Code § 1636, reading the document as a whole under section 1641 and favoring a workable reading under section 1643. Together they let a judge repair a broken cross-reference from the rest of the deal. If doubt remains, Cal. Civ. Code § 1654 construes it against “the party who caused the uncertainty to exist.” Usually that is the buyer, whose lawyer wrote the draft.

California is also unusually open to outside evidence. Pacific Gas & Electric Co. v. G.W. Thomas Drayage & Rigging Co., 69 Cal. 2d 33 (1968), asks whether the evidence supports a meaning to which the words are “reasonably susceptible,” not whether the text looks plain to the judge. Cal. Code Civ. Proc. § 1856 bars testimony contradicting a fully integrated writing, but Riverisland Cold Storage, Inc. v. Fresno-Madera Production Credit Ass’n, 55 Cal. 4th 1169 (2013), admits fraud evidence even when it contradicts the written terms.

What does “$1.00 and other good and valuable consideration” actually promise?

Less than most sellers assume. Cal. Civ. Code § 1614 treats a signed writing as presumptive evidence of consideration, so the recital keeps the contract alive. But the phrase never says whether the buyer owes an earn-out or must retire the company’s bank line. Those are real dollars a buyer may later deny promising.

The merger clause closes the trap. If the court finds the writing was meant as the complete and exclusive statement of the deal, section 1856(b) blocks the seller from adding side terms through testimony. The seller is left arguing ambiguity or fraud, and either one means a trial. I would rather see the numbers typed into the agreement.

Will the buyer’s noncompete hold up under California law?

Often it will not. Cal. Bus. & Prof. Code § 16600 voids contracts restraining anyone from a lawful business. Effective January 1, 2024, AB 1076 added section 16600.1, barring noncompliant noncompetes in employment contracts, and SB 699 added section 16600.5, which gives employees a private right of action with attorney’s fees.

The exception in section 16601 applies when the seller sells goodwill or disposes of all of his or her ownership interest. A seller who keeps 10 percent, as in Dandurand, has not sold all of it. Hill Medical Corp. v. Wycoff, 86 Cal. App. 4th 895 (2001), voided a physician’s covenant because the buyout paid nothing for goodwill, requiring a clear sign the parties “valued or considered goodwill as a component of the sales price.” A one-dollar stated price is not that sign.

Moving the covenant into the seller’s employment agreement does not reliably help. In Fillpoint, LLC v. Maas, 208 Cal. App. 4th 1170 (2012), an employment covenant running past the purchase agreement’s three-year covenant was unenforceable.

Can a bankruptcy filing undo a signed sale agreement in the Ninth Circuit?

Yes, if the deal is still executory when the case is filed. 11 U.S.C. § 365(a) lets a debtor reject an executory contract with court approval. The Ninth Circuit applies the Countryman test, and sitting en banc in In re Robert L. Helms Construction & Development Co., 139 F.3d 702 (9th Cir. 1998), it asked whether, at filing, each party has “something it must do to avoid materially breaching the contract.” A signed stock sale that has not closed usually qualifies, since shares and money are both still owed. That cuts both ways: a buyer that files before closing can reject, too.

The standard is forgiving. Agarwal v. Pomona Valley Medical Group, Inc. (In re Pomona Valley Medical Group, Inc.), 476 F.3d 665 (9th Cir. 2007), adopted the business judgment rule and directs approval unless rejection is “so manifestly unreasonable that it could not be based on sound business judgment.”

What is a seller left holding if the buyer rejects the deal?

A damages claim, usually unsecured. Section 365(g) treats rejection as a breach immediately before the petition, and 11 U.S.C. § 502(g) allows the claim as a prepetition one. Mission Product Holdings, Inc. v. Tempnology, LLC, 587 U.S. 370 (2019), confirmed that rejection works like an ordinary breach rather than a rescission. The seller keeps the shares and claims the lost bargain in bankruptcy dollars, the position I discussed for California creditors facing a Chapter 11 debtor.

Watch the cap. If part of the payout was salary under an employment agreement, section 502(b)(7) limits damages for ending it to one year of pay plus unpaid amounts. And once the deal has closed with money still owed on a note, there is usually nothing left to reject; the seller is simply a creditor.

What protections should a California seller demand before signing?

Close in escrow if you can, signing and closing the same day with stock released only when the cash clears. That removes the window in which either side can file. If the two must be separated, insist on a dated agreement with every schedule attached.

Seller financing is where I see owners take the most risk, so take a security interest in what you sold. Under Cal. Com. Code § 9203, it becomes enforceable once value is given and the buyer signs a security agreement describing the collateral. Keeping the endorsed share certificate gives control under section 8106, which perfects under section 9314; equipment and receivables need a financing statement under section 9310. Private equity buyers often close through a new shell company, so ask for a guaranty from the fund or its principals and objective release terms for any holdback.

How would the tax bill look for a Rancho Cucamonga seller?

Take an illustrative case: Maria owns all the stock of an S corporation running an HVAC service company in Rancho Cucamonga, with a $200,000 stock basis. In November 2026 a buyer offers $2.4 million: $1.2 million cash at closing, a $600,000 note paid over 2027 and 2028, and a $600,000 earn-out tied to 2027 revenue. The draft recites one dollar plus “other” consideration and bars her from competing anywhere in Southern California for five years.

As a CPA, my first question is what price the return will report, because gain is amount realized minus basis. Reported all in 2026, the $2.2 million gain is ordinary income in California; the Franchise Tax Board says the state has no lower capital gains rate. On the 2025 single schedule, ignoring deductions and other income, that is roughly $263,000, about $12,000 of it from the 1 percent that Cal. Rev. & Tax. Code § 17043 adds above $1 million (13.3 percent at the top). Under the installment method of 26 U.S.C. § 453, which California follows through section 17551, about $1.1 million of gain lands in 2026 and the rest as payments arrive, which cuts that surcharge to about $1,000.

In an asset deal, 26 U.S.C. § 1060 requires an allocation reported on IRS Form 8594, binding both sides if agreed in writing, and debts the buyer assumes count as price under Treas. Reg. § 1.1001-2(a)(1). The buyer amortizes a noncompete over 15 years under 26 U.S.C. § 197, while Maria generally reports that slice as ordinary income. A real goodwill allocation is also the evidence Hill Medical asks for, so negotiate the allocation and the noncompete together.

Frequently Asked Questions

Can I get out of a business sale agreement I already signed in California?

Sometimes. Outside bankruptcy you need a contract defense, such as fraud or a material breach by the buyer. A seller who files bankruptcy before closing can ask to reject the agreement as an executory contract, and Ninth Circuit courts defer to the debtor’s business judgment. Rejection is not free; the buyer keeps a damages claim.

Is a $1.00 purchase price enforceable in California?

Usually the contract survives, because California presumes a signed writing has consideration. The fight is over what “other consideration” means. Vague terms are construed against the party who drafted them, typically the buyer, but proving the real price can take testimony and a trial. Writing every price term into the agreement avoids that dispute.

Can a buyer enforce a noncompete if I keep a minority stake?

Probably not under the stock-sale branch of Business and Professions Code section 16601, which covers an owner disposing of all of his or her ownership interest. A buyer could argue goodwill was sold, but courts read the exception narrowly. A retained stake plus a nominal stated price makes that argument much weaker.

What happens to my seller note if the buyer files bankruptcy?

Without collateral, the note is a general unsecured claim, often paid at a steep discount. A security interest in the stock or assets you sold, perfected under the California Commercial Code before the filing, makes you a secured creditor instead. A guaranty from the buyer’s owners gives you a second source of payment.

Does California tax the gain on selling my business at a lower rate?

No. California taxes capital gains as ordinary income, so a large sale can hit the 12.3 percent bracket plus a 1 percent surcharge on taxable income above $1 million, a 13.3 percent top rate. Installment reporting, which California generally follows, spreads the gain over the years you actually collect it.

How North Star Law Firm Can Help

North Star Law Firm reviews and negotiates purchase agreements for California owners in the Inland Empire, the Sacramento area and statewide through its buying and selling a business and contract drafting and review practices, and models the tax side of the same deal through business sale tax structuring. When one side of a signed deal is already in financial trouble, the firm also advises on the bankruptcy consequences. Phillip Zagotti is a California attorney and a CPA, admitted to the U.S. Bankruptcy Court for the Central District of California.

If a buyer has handed you a purchase agreement, contact North Star Law Firm or schedule a consultation before you sign.

You own a rental in Temecula or Elk Grove, or are in escrow on one, and someone told you to “put it in an LLC.” The advice was free. The LLC costs at least $800 a year in California and changes how Prop 13 treats the property from then on.

For most owners of one or two financed rentals, a revocable trust plus a large umbrella policy does the job for less. An LLC earns its keep when there is serious equity or a co-owner who is not your spouse. A corporation almost never does.

What does a California LLC cost a rental owner every year?

Under Rev. & Tax. Code § 17941, every LLC organized, registered, or doing business here pays $800, profit or no profit, on FTB Form 3522. The 2021 to 2023 first-year exemption is gone, but SB 122 added section 17941(g)(2): a first taxable year beginning in 2027 through 2029 costs $400. If you are forming one near year end, wait for January.

Section 17942 adds a fee of $900 once California “total income” reaches $250,000, rising to $2,500 at $500,000, $6,000 at $1 million, and $11,790 at $5 million. Because total income is gross income plus cost of goods sold, a landlord counts gross rent, not profit.

Filing Form LLC-1 with the Secretary of State costs $70, and the Statement of Information that Corp. Code § 17702.09 requires within 90 days and every two years costs $20. A limited partnership owes $800 under section 17935, and an S corporation pays 1.5 percent of net income under section 23802(b), never less than $800.

A Nevada or Wyoming LLC escapes none of this. Section 23101 treats an entity as doing business here once its California property passes an indexed threshold ($75,707 for 2025). One house in Menifee clears it.

What does an LLC protect a California landlord from?

Under Corp. Code § 17703.04(a), LLC debts do not become a member’s debts “solely by reason of the member acting as a member.” If a guest falls on a broken stair at the Fontana rental, the judgment reaches that equity, not your Rancho Cucamonga home.

Your own conduct is not shielded. Frances T. v. Village Green Owners Assn., 42 Cal.3d 490 (1986), holds that the corporate form never insulated officers from their own torts, so a self-managing owner who ignored the repair request is sued personally. Section 17703.04(b) imports alter ego rules, and rent deposited to a personal account invites them.

Against personal creditors, section 17705.03(f) makes the charging order the “exclusive remedy,” but subdivision (b)(3) lets a court foreclose and sell the interest. Hellman v. Anderson, 233 Cal.App.3d 840 (1991), allowed that without the other partners’ consent. A single-member LLC has no other partners to protect.

For one rental, insurance does more. An umbrella pays defense costs and the claim; an LLC only limits collection afterward.

Will moving a rental into an LLC trigger Prop 13 reassessment or transfer tax?

Not if proportions match. Rev. & Tax. Code § 62(a)(2) excludes a transfer that changes only the method of holding title when proportional interests stay the same, and section 11925(d) exempts that deed from documentary transfer tax.

The catch: under section 64(d), the owners become “original coowners,” and once more than 50 percent of those interests transfer cumulatively, the whole property is reassessed. Section 64(c) does the same when anyone takes control. No deed records these moves, so the acquirer files BOE-100-B within 90 days under sections 480.1 and 480.2 or owes the section 482(b) penalty of 10 percent of the taxes on the new base year value.

In 926 North Ardmore Avenue, LLC v. County of Los Angeles, 3 Cal.5th 319 (2017), the Supreme Court held the tax under section 11911 “may be imposed when a transfer of a legal entity results in a change in ownership of real property under section 64, subdivision (c) or (d).”

Prop 19 ended the parent-child exclusion for rentals, but deeding a child a 40 percent cotenancy share reassesses 40 percent, while gifts carrying children past half of an LLC’s original coowner interests reassess all of it. A family home in an LLC also loses the section 63.2 exclusion (factored base year value plus $1,044,586 through February 15, 2027), because real property “does not include any interest in a legal entity.” Property Tax Rule 462.180 agrees.

How is rental income taxed in an LLC, and why not an S corporation?

A single-member LLC is disregarded and a multi-member LLC is a partnership by default under Treas. Reg. § 301.7701-3(b)(1), and Rev. Proc. 2002-69 lets California spouses report a community property LLC either way.

The loss rules ignore the entity. The section 469(i) $25,000 allowance phases out between $100,000 and $150,000 of AGI, and the 750-hour professional test in section 469(c)(7) is unchanged. The 20 percent deduction under IRC § 199A is now permanent, with a 250-hour rental safe harbor in Rev. Proc. 2019-38, but the Form 568 instructions confirm California “does not conform.”

Corporations trap appreciation. Under IRC § 311(b), distributing appreciated property is taxed as a sale. C corporation shareholders are taxed again; S corporation owners take the gain on a K-1 with no cash to pay it.

The pass-through entity elective tax, extended through 2030 by SB 132, lets a partnership or S corporation pay 9.3 percent that is deductible federally under Notice 2020-75. With the SALT cap at $40,400 for 2026 under IRC § 164(b)(7), many couples under the $505,000 phasedown gain little, and a disregarded LLC cannot elect.

How does the LLC fit with your revocable trust?

The LLC holds the deed; each spouse assigns the membership interest to the trustee of the revocable trust, and the operating agreement’s successor manager should match the successor trustee.

Community property held directly gets a full step-up at the first death under IRC § 1014(b)(6). In a partnership-taxed LLC, the interest steps up but the building’s inside basis does not follow without a section 754 election; a disregarded spousal LLC avoids that.

A Delaware statutory trust is different: Rev. Rul. 2004-86 treats a passive DST interest as real property for a like-kind exchange. Before exchanging into one outside California, read our post on the Form 3840 clawback.

How do the numbers work for a Roseville couple with two rentals?

A Roseville couple holds a Natomas house (value $560,000, loan $190,000) and an Elk Grove duplex (value $690,000, loan $380,000 at 3.1 percent) in their revocable trust. Gross rent is $84,600 a year. All figures are illustrative.

Option one keeps both in the trust and adds a $2 million umbrella, perhaps $600 a year. There is no entity tax or Form 568, and 12 U.S.C. § 1701j-3(d)(8) kept the lenders from calling the loans over the transfer to the trust.

Option two gives each property its own LLC: $1,600 a year, two Forms 568, no section 17942 fee at this rent. The deeds fit section 62(a)(2), making the couple original coowners twice over. The $370,000 of house equity is walled off from a duplex claim. Option three puts both in one LLC for $800, and a duplex judgment can then reach both.

The loan decides it. Section 1701j-3(d) protects a transfer to a revocable trust, not a deed to an LLC, so the duplex lender could accelerate that 3.1 percent loan. Get written consent first, and ask the title insurer whether the owner’s policy follows the deed.

The LLC route adds Forms 3522 and 568 each April 15, biennial Statements of Information, and BOE-100-B whenever interests move. Either way, contractors paid $2,000 or more get a 1099 under IRC § 6041(a). FinCEN no longer requires beneficial ownership reports from domestic companies. For this couple, option one wins until the equity grows.

Frequently Asked Questions

Do I have to pay the $800 California LLC tax if my rental loses money?

Yes. Revenue and Taxation Code section 17941 imposes it on every LLC organized, registered, or doing business in California, profit or not, until the LLC is cancelled. For a first taxable year beginning in 2027 through 2029, it drops to $400. The separate fee starts at $250,000 of gross receipts.

Will putting my rental in an LLC trigger a Prop 13 reassessment?

Not if the LLC is owned in the same proportions as the property, under Revenue and Taxation Code section 62(a)(2). The owners become original coowners under section 64(d), though, so once more than 50 percent of their interests transfer cumulatively, the whole property is reassessed and a BOE-100-B is due within 90 days.

Can a Nevada or Wyoming LLC avoid California tax on a California rental?

No. Under Revenue and Taxation Code section 23101, an entity is doing business in California when its California property exceeds an indexed threshold, $75,707 for 2025. One rental house clears that, so the out-of-state LLC owes the $800 tax and files Form 568 on top of its home state’s fees.

Does my lender have to approve moving my rental into an LLC?

Practically, yes. The Garn-St Germain Act, 12 U.S.C. section 1701j-3(d), bars due-on-sale enforcement for a transfer into a trust where the borrower remains a beneficiary, but has no exception for a deed to an LLC. The lender could accelerate. Get written consent before recording.

Should my revocable trust own the rental or the LLC?

The LLC holds the deed, and your trust holds the membership interest by written assignment. That avoids probate and lets the successor trustee step in. Match the operating agreement’s successor manager to the trust, and consider a section 754 election if the LLC is taxed as a partnership.

Is an S corporation a good way to own California rental property?

Rarely. California taxes S corporation net income at 1.5 percent with an $800 minimum, and under IRC section 311(b) distributing appreciated property out of a corporation triggers gain as if it were sold. The building also gets no inside step-up at death. An LLC avoids both problems.

How North Star Law Firm Can Help

North Star Law Firm advises rental owners across the Inland Empire and the Sacramento area on entity formation, real estate tax planning, and fitting an LLC inside a revocable living trust. Phillip Zagotti is a California attorney and a CPA admitted to the U.S. Tax Court, so the same person drafts the operating agreement and prepares the Form 568.

If you own or are buying a rental and are weighing an LLC, contact North Star Law Firm or schedule a consultation.

An Ontario distributor can buy the equipment, customer list, and brand of a Fontana manufacturer that filed Chapter 11. The price is good because the company is broke. The question is whether the buyer also inherits what broke it: warranty claims, a product defect, back sales tax, unpaid payroll contributions.

A sale order under 11 U.S.C. § 363(f) is a buyer’s best protection against California’s broad successor liability rules. It is not a complete shield. California’s tax successor statutes run on their own administrative track, and a notice defect can reopen claims the order was supposed to end.

What protection does a bankruptcy sale under section 363 give a buyer?

Section 363(f) allows a sale “free and clear of any interest in such property of an entity other than the estate” if one of five conditions is met. For claimants, the key one is paragraph (5): the holder “could be compelled, in a legal or equitable proceeding, to accept a money satisfaction of such interest.”

BowFlex filed Chapter 11 in March 2024. Johnson Health Tech bought the business under an order that covered “products liability” claims and enjoined claimants from suing the purchaser. After a June 5, 2025 dumbbell recall, owners of older units filed four putative class actions, one in the Northern District of California. The bankruptcy judge directed dismissal, and Judge Christine P. O’Hearn affirmed in Proposed Class Representatives v. BowFlex Liquidating Trust, No. 25-cv-14953 (D.N.J. July 30, 2026).

Section 363(m) protects a good-faith purchaser if the order is reversed on appeal without a stay; fraud or collusion defeats good faith. In re Filtercorp, Inc., 163 F.3d 570 (9th Cir. 1998). But Clear Channel Outdoor, Inc. v. Knupfer (In re PW, LLC), 391 B.R. 25 (9th Cir. BAP 2008), held that section 363(m) did not shield the free-and-clear component, read (f)(3) to bar stripping a lien when the price does not exceed the liens, and required an (f)(5) seller to identify a real proceeding that could force the lienholder to take less. Buyers respond with lienholder consent, an evidentiary (f)(5) record, and closing after the 14-day stay in Rule 6004(h).

Can a sale order cut off California’s product-line successor liability?

Under Ray v. Alad Corp., 19 Cal.3d 22 (1977), an asset buyer takes the seller’s debts only through “an express or implied agreement of assumption,” a de facto merger, a “mere continuation of the seller,” or a transfer made “for the fraudulent purpose of escaping liability for the seller’s debts.”

Then Ray went further. A party that “acquires a manufacturing business and continues the output of its line of products” takes strict liability for defects in units its predecessor made, justified first by “the virtual destruction of the plaintiff’s remedies against the original manufacturer.” A bankrupt manufacturer is the textbook case.

In re Catalina Sea Ranch, LLC, No. 2:19-bk-24467-NB (Bankr. C.D. Cal. Apr. 13, 2020), held that “a claim for ‘successor liability’ is an ‘interest’ in the property being sold,” following the Third and Fourth Circuits. The Seventh Circuit, in Zerand-Bernal Group v. Cox, 23 F.3d 159 (7th Cir. 1994), would not let a bankruptcy court enjoin a product suit by someone injured after the case wound up. We have not located a published Ninth Circuit decision resolving the split, and BowFlex did not reach it because the plaintiffs had conceded the point below. The Catalina debtor had first tried an assignment for the benefit of creditors, which offers no such order.

What does a sale order not reliably wipe out for a California buyer?

Sales tax first. Rev. & Tax. Code § 6811 requires a successor to “withhold sufficient of the purchase price” until the seller produces a receipt or no-tax-due certificate, and section 6812 makes a buyer who fails to withhold liable “to the extent of the purchase price.” Regulation 1702(a) exempts “sales by trustees in bankruptcy.” But Annotation 535.0016 (2003) says that exemption does not cover Chapter 11 debtors in possession; that buyer escaped only because the sale order expressly extinguished pre-closing taxes.

Payroll has no bankruptcy carve-out. Unemp. Ins. Code § 1731 requires a buyer of “substantially all the assets” of an employer to withhold unpaid contributions until EDD certifies none are due. EDD has 30 days to answer under section 1732, and section 1733 caps the buyer’s liability at the purchase price.

Bulk-sale law is the clean exemption: Com. Code § 6103(c)(7) excludes sales by a “trustee in bankruptcy, debtor in possession.” Wages are not. Labor Code § 200.3 makes a successor liable on a final wage judgment against the old employer if it uses “substantially the same facilities or substantially the same workforce.” An assigned lease comes with its defaults, which 11 U.S.C. § 365(b)(1) requires to be cured.

What should a California customer or employee do after seeing a sale notice in the newspaper?

Due process requires “notice reasonably calculated, under all the circumstances, to apprise interested parties.” Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306 (1950). A creditor whose identity is “reasonably ascertainable” gets mailed notice. Tulsa Professional Collection Services, Inc. v. Pope, 485 U.S. 478 (1988). Unknown creditors can be bound by publication.

That line decided BowFlex. The debtor had logged 337 complaints, but the record did not show what they said or who sent them, so the plaintiffs stayed unknown.

If a company that hurt you or owes you wages is selling in bankruptcy, object before the deadline, file a proof of claim before the bar date under Rule 3003(c), and write to debtor’s counsel so no one can later call you unknown.

Where does the CPA work change the size of the deal?

A 363 purchase is an applicable asset acquisition under IRC § 1060, allocated by the residual method and reported on Form 8594. The buyer gets a stepped-up cost basis, though California does not follow federal bonus depreciation. Real property is a change in ownership under Rev. & Tax. Code § 60, and Florida Department of Revenue v. Piccadilly Cafeterias, Inc., 554 U.S. 33 (2008), limits the bankruptcy stamp-tax exemption to confirmed plans, so a 363 sale pays documentary transfer tax.

The holdback comes from the books. I tie the quarterly DE 9 returns to actual deposits and the sales tax returns to general ledger revenue, then read the warranty reserve against the claims log. A $40,000 reserve against $350,000 of claims history tells you what the order is really protecting.

How does this work when an Ontario buyer acquires a Fontana manufacturer?

Assume a Fontana maker of food-service equipment files Chapter 11 in the Central District of California, and an Ontario company bids $6.2 million: $2.4 million for the plant, $2.1 million for equipment, $0.6 million for inventory, and $1.1 million of goodwill. Diligence shows about $265,000 of unpaid sales tax, $92,000 of EDD contributions, and 1,900 units under warranty. All figures are illustrative.

The APA assumes only post-closing liabilities. The sale order names product, warranty, successor, and tax claims, enjoins claimants, and holds $400,000 of proceeds in a segregated account until CDTFA and EDD issue certificates or are paid. The debtor mails notice to 60 customers who already reported weld failures, and the buyer honors warranty repairs as a customer program, not an assumed debt.

After closing, the county tax under section 11911 on $2.4 million is $2,640, plus any city tax, and the Form 8594 numbers should match what the assessor sees.

Frequently Asked Questions

Does buying assets in a bankruptcy sale protect me from the seller’s product liability in California?

Usually, if the sale order expressly covers product and successor claims and notice was adequate. Otherwise, the Ray v. Alad Corp. product-line rule can make a buyer who continues the line liable for units the seller made. A Central District bankruptcy court has held that successor liability is an interest a section 363(f) sale can cut off.

Will CDTFA pursue me for the seller’s unpaid sales tax?

It can. Revenue and Taxation Code sections 6811 and 6812 make a buyer who does not withhold liable up to the purchase price. Regulation 1702 exempts sales by bankruptcy trustees, but agency legal staff has said that does not cover Chapter 11 debtors in possession. Request a certificate and hold back part of the price.

Do I need a bulk sale escrow when buying from a bankruptcy estate?

No. California Commercial Code section 6103(c)(7) excludes sales by a trustee in bankruptcy or a debtor in possession from the bulk sale rules. That exemption does not reach the tax successor statutes, so you still deal with CDTFA and with EDD under Unemployment Insurance Code sections 1731 through 1733.

What did the court decide in the BowFlex case?

On July 30, 2026, the federal district court in New Jersey affirmed an order requiring dismissal of four class actions against Johnson Health Tech, which bought BowFlex’s assets. The sale order foreclosed defect suits against the new owner, and the plaintiffs were bound by newspaper or email notice.

Am I bound by a sale order if I only saw a newspaper notice?

Possibly. If the debtor did not know and could not reasonably ascertain your claim, publication can satisfy due process under Mullane v. Central Hanover Bank and Trust Co. If the debtor knew about you, you were entitled to mailed notice. Either way, act before the objection deadline and the bar date.

How is the purchase price allocated in a section 363 sale?

Under Internal Revenue Code section 1060, by the residual method, with goodwill taking what is left, reported on Form 8594. The allocation drives the buyer’s depreciation, and in California it also affects property tax reassessment of any real property and the documentary transfer tax.

How North Star Law Firm Can Help

North Star Law Firm represents buyers across the Inland Empire and the Sacramento area in buying a business out of bankruptcy, from the APA and sale order to purchase price allocation and CDTFA and EDD clearances, and advises customers and employees with claims in a bankruptcy case. Phillip Zagotti is a California attorney and a CPA admitted to the U.S. Bankruptcy Court for the Central District of California.

If you are buying assets from a bankrupt California company, or hold a claim against one, contact North Star Law Firm or schedule a consultation.