The 2022-23 Budget: Secretary of State Request to Waive Business Filing Fees

The 2022-23 Budget: Secretary of State Request to Waive Business Filing Fees FEBRUARY 2022 Summary. In this post we analyze the for the business’ debts and other liabilities. Governor’s proposal to waive the filing fee paid Nearly 70 percent of California’s 5 million when a new limited partnership (LP), limited liability businesses are sole proprietorships. company (LLC), or corporation is registered with • General Partnerships. When two or more the Secretary of State (SOS) for the fiscal year of individuals decide to jointly own and operate 2022-23. Under the proposal, the General Fund a business, they form a partnership. A general would provide SOS $39.8 million to backfill the partnership is similar to a sole proprietorship loss of fee revenue. The stated purpose of the in that the owners are equally responsible for proposed fee waiver is to encourage business any debts or other liabilities of the business. growth in California. Because we do not view • Limited Partnerships. Unlike general the business filing fees to be a barrier for new partnerships, LPs provide business owners businesses, we recommend that the Legislature with limited liability protection. This means reject the proposal—freeing up the funding for other that the owners are not personally liable for legislative priorities. If the Legislature chooses to the business’s debts. An individual or another approve the proposal, we recommend amendments company may be a partner in an LP. to budget bill language to clarify legislative intent. • Limited Liability Companies. An LLC also In addition, we identify that the SOS Business Fees provides owners (members) with limited Fund requires attention as it seems that its fee liability protection but is legally distinct from its levels may be too high and recommend that the owners. An LLC may be owned by individuals administration evaluate the fund’s fees and reserve or companies. An LLC may have just a levels in light of desired service levels. single member. • Corporation. A corporation also provides BACKGROUND liability protections and is a business that is Business Entities legally distinct from its owners (shareholders). Individuals or companies may own a Businesses Are Organized in Different Ways. corporation. A corporation may have just Businesses take a variety of forms depending a shareholder. on the complexity of their ownership and management structure. The primary considerations SOS Business Filings for determining which form to take include the Corporations, LLCs, and LPs File Information number of owners, whether the owners are all With and Pay Fees to SOS. In order to establish actively involved in managing the business, and a corporation, an LLC, or an LP in California, whether the owners need or want protection from applicants first must register the new business financial liabilities. We discuss five major types of entity with SOS and pay a filing fee. This initial filing business organizations below. fee is $100 for corporations and $70 for LLCs and • Sole Proprietorships. A sole proprietorship LPs. This fee level has been in place for at least is owned and managed by an individual. It is the past 20 years. In addition, there are a number the most basic and most prevalent form of of other types of filings and fees that businesses business entity. The owner is personally liable submit to SOS. 2022-23 Budget Series 1 Business Filing Fees Are Revenue Source of entities in California. Further, the request indicates Special Fund. The fees paid to SOS by business that the number of filings has grown considerably entities are the primary revenue source for the over the past few years—from 289,879 in 2018 to SOS’s Business Fees Fund. The Business Fees 343,877 in 2020 and—through November 30— Fund is established under Section 12176 of the 396,290 in 2021. This growth in new business entity Government Code, which specifies that (1) the formations has been occurring under the existing Business Fees Fund be used to support the fee structure. Although new businesses may programs from which fees are collected, (2) the appreciate the one-time filing fee relief, we doubt fees collected shall be sufficient to cover the that the administration’s proposal would do much, if costs of these programs, and (3) up to $1 million anything, to stimulate meaningful business growth. may remain in the fund with any additional excess Business Filing Fee and Reserve Structure funds being transferred to the General Fund at the Needs Attention. The Business Fees Fund end of each fiscal year. The fee levels charged to consistently has a fund balance in excess of business entities are specified in the Government $1 million at the end of the fiscal year. This has Code, beginning with Section 12180. The Business resulted in significant sums of money being Filing Fee is a significant fund source for SOS and transferred from the Business Fees Fund to the typically pays for more than one-third of the General Fund. For example, between 2011-12 and department’s expenditures. 2020-21, the General Fund received $179 million from the special fund. The amount transferred PROPOSAL to the General Fund has varied significantly year Waive New Business Filing Fees for 2022-23. to year, ranging from $5 million in 2011-12 to For the fiscal year of 2022-23, the administration $36 million in 2017-18. As a percentage of revenues, proposes waiving the filing fee paid when a new the transfer to the General Fund has varied from business entity is registered with SOS. The stated 9 percent of fee revenues in 2019-20 to 41 percent purpose of this proposal is “to encourage business of fee revenues in 2017-18. The consistent and growth in California.” Based on the fund condition large transfers to the General Fund suggest that statement, the administration estimates that this business entities have been paying higher fees than proposal would reduce revenues to the Business are necessary to support the program. The fee Filing Fund by about 45 percent—or $39.8 million. structure should be designed so that businesses To support SOS operations that are funded by the pay fees that are at a level that is reasonable for the Business Filing Fund, the administration proposes support of the program. That being said, lowering that the General Fund be used to backfill the special fees creates risk that the special fund might not fund with a one-time General Fund appropriation have sufficient resources in a particular year. This of $39.8 million. is demonstrated by the volatility in revenues to the fund. For example, between 2011-12 and 2020-21, LAO COMMENTS year-over-year growth in revenues ranged from a 40 percent increase in revenues between 2013-14 Waiving Fee Likely Would Do Little to and 2014-15 (from $50.7 million to $71.1 million) Stimulate Business Growth Businesses likely and a 5 percent decrease between 2017-18 and consider the filing fees an unwelcome cost. 2018-19 (from $87.8 million to $83.3 million). The However, the proposed one-time fee waiver current reserve limit of $1 million makes it difficult would provide limited financial assistance to new for SOS to charge businesses a lower fee while still businesses relative to the overall cost of starting a fulfilling the requirements of Section 12176 that the new business. These costs—such as equipment, fund be self-sufficient. A higher reserve limit for the construction costs, employee salaries, and rent— fund would allow a lower fee for all businesses while often sum to tens of thousands of dollars, or still providing that the fund is self-sufficient. considerably more. Paying a $100 or $70 fee likely is not a barrier to the formation of new business 2022-23 Budget Series 2 California Business Connect (CBC) Should 1. It is the Legislature’s intent to encourage Change SOS Operations. The CBC project business growth in California by waiving fees is automating the business filing processes at established in state law for the creation of SOS. While many processes already have been business entities for the fiscal year of 2022-23. automated under the project, filings related to Specifically, (1) filing fees pursuant to Section business entities is the last module to be rolled 12186, subsections (c), (d), (e), or (f), of the out. This module is scheduled to be completed by Government Code shall not be required to April 2022. The project is scheduled to be through be paid to the Secretary of State, (2) filing maintenance and operations by April 2023. Once fees pursuant to Section 12188, subsections fully operational, CBC will fundamentally change (b) or (c), of the Government Code shall not be SOS operations. This could lead to changes in required to be paid to the Secretary of State, revenues and resource needs for the program. and (3) filing fees pursuant to Section 12190, Budget Bill Language Could Be Clearer. subsections (b) or (c) of the Government The administration proposes budget bill language Code shall not be required to be paid to the to implement its plan to waive filing fees for new Secretary of State. business entities. Specifically, provision one Direct Administration to Evaluate Fund of the language states that the $39.8 million Structure. Regardless of whether or not the General Fund appropriation “shall be limited to Legislature approves the proposal, we think backfilling revenues related to waiving first-time that the Business Fees Fund requires attention. Secretary of State filing fees for businesses The appropriate structure of the fund will not be (corporations, limited liability companies and limited known until the operational needs become clearer partnerships).” If the Legislature is interested in in a year or two after CBC is fully operational. adopting this fee waiver, this language could be We recommend that the Legislature direct the clearer as to which fees are waived for 2022-23. administration to include, with any future proposals related to the business filing division, a justification LAO RECOMMENDATIONS for existing fee levels and how those levels align with services provided by the SOS. After the full Reject Proposal. Because we do not view implementation of CBC, the Legislature could the business filing fees to be a barrier for new consider requiring SOS to report on options that businesses, we recommend that the Legislature align the fees for the Business Fees Fund with reject the proposal. Instead, we recommend that desired service levels. The report should include the Legislature use the proposed $39.8 million in an analysis of (1) the fee levels, (2) service costs, a more targeted manner that achieves legislative (3) reserve levels, and (4) mechanisms for annual priorities—whether that be encouraging business fee adjustments based on reserves. growth in California or supporting other legislative priorities supported by the General Fund. If Adopting Proposal, Modify Budget Bill Language. If the Legislature chooses to waive fees paid by new LPs, LLCs, and corporations, we recommend that the Legislature modify the proposed budget bill language to clarify legislative intent. Specifically, we would recommend that provision one under Item 0890-011-0001 be replaced with the following language: 2022-23 Budget Series 3 LAO PUBLICATIONS This post was prepared by Nick Schroeder, and reviewed by Ginni Bella Navarre and Carolyn Chu. The Legislative Analyst’s Office (LAO) is a nonpartisan office that provides fiscal and policy information and advice to the Legislature. 2022-23 Budget Series 4