I have found over the years that many people do not understand the importance of avoiding forfeiture of their company's right to do business in the State of Texas for failing to comply with their state tax obligations. People do not understand how they can lose their charter or right to do business, or the significance of having lost their corporate privileges. It's a big deal that is easy to avoid but which has tremendously bad consequences if one fails to keep their business entity in good standing.
Forfeiture of a corporation, limited liability company, limited partnership, or other filing entity’s corporate privileges in Texas occurs when (1) the filing entity does not file the report required by Chapter 171 of the Texas Tax Code; (2) the filing entity fails to pay its franchise taxes within 45 days after the notice of forfeiture is mailed to the filing entity; or (3) when the filing entity does not permit the Texas comptroller to examine the filing entity’s records pursuant to Section 171.211 of the Texas Tax Code. Unfortunately, for business owners, forfeiture is extremely common in Texas.
What’s the Significance of a Business Entity Forfeiting its Right to do Business in Texas?
While forfeiture of corporate privileges is an all-too-common occurrence, few business people in Texas realize the significance of forfeiture and its potential impact on not only the business but a corporation’s officers and directors as well. Tex. Tax Code § 171.152 states that if a corporation’s privileges are forfeited, the corporation is denied the right to sue or to defend a lawsuit in a Texas court (although courts have subsequently decided that the forfeited entity is entitled to defend a lawsuit; it just is not allowed to assert any claims it may have). Additionally, and equally important, § 171.252 states that each officer and director of a forfeited corporation is liable for the debts and obligations of the forfeited corporation (subject to § 171.255). Given that the liability shield and the shield from suits on company obligations are two very important primary purposes for forming a corporation or other limited liability entity, one would think that this would be enough to get people to pay attention. Sadly, this is not the case.
Why Does Forfeiture of Corporate Privileges Occur So Frequently in Texas?
First, many businesses simply don’t keep up with their mail. The Comptroller contacts businesses via mail to give them advance warning of forfeiture. The Comptroller gives a number of notices prior to requiring the Secretary of State to forfeit the filing entity. Despite this, many of these notices are not seen or dealt with in a responsible or timely manner.
A second contributing factor to forfeiture in Texas is simply a lack of understanding of a business’ obligations. The repeated modifications to the Texas Franchise Tax have caused confusion about when reports are due and who must report. Generally, all taxable entities must now report except for some narrow exceptions. Nevertheless, many businesses believe that if do not owe franchise taxes, they do not need to file anything.
The third contributing factor to forfeiture is a business simply failing to file the its annual information report along with its franchise tax return. Many businesses fail to file a complete return (including the annual report) which prevents the Comptroller from accepting the filing. Thus, despite filing its proper form for indicating whether or not it owes taxes, the business simply failed to attach the information report which the Comptroller requires.
Lastly, many business owners in Texas use forfeiture to “wind down” their business. Rather than go through the process of winding down the business through filing a certificate of termination, the owners simply let the business go into forfeiture. Given the potential liability issues inherent in forfeiture, this is obviously a terrible way to end a business, particularly given that if a business is properly wound up, it can keep its liability shield. Further discussion of the forfeiture/termination issue as it relates to winding up a business will be reserved for future discussion.
Just as Texas grants the owners of filing entities a liability shield via the Texas Business Organizations Code (or predecessor statute), so can Texas remove that shield via the Tax Code. The bottom line is that business owners in Texas rarely give forfeiture the consideration it merits. More often than not, forfeiture of corporate privileges is discovered during some crucial moment (purchase/sale of a business, filing of a lawsuit, etc.), resulting in owners and attorneys scrambling to reinstate the business entity’s privileges.
Please contact us at 713-388-6150 or by email at firstname.lastname@example.org if you have any questions about forfeiture issues.
Jeff Jansen is the founding member of the Jansen Law Firm, PLLC and has more than 20 years of experience as a business and trial attorney.