On July 22, 2014, the California Franchise Tax Board (FTB) released Legal Ruling 2014-01 describing when businesses entities that are members of multiple-member limited liability companies (LLCs) must file a tax return and pay any applicable taxes and fees.

The conclusion of the FTB is that a business entity member of an LLC must file a California tax return and pay any applicable taxes and fees if the LLC is doing business in California. An LLC is doing business in California if:

  • It is organized or commercially domiciled in California, or
  • Its California sales, property, or payroll exceed the amounts then applicable under paragraphs (2), (3), or (4), of subdivision (b) of section 23101 of the Revenue and Taxation Code.

The FTB has determined that the “business of the partnership is the business of each partner,” and “the activities of the partnership are attributed to each partner, with the consequence that in geographic locations where the partnership is ‘doing business,’ the partners are also ‘doing business.’” The FTB makes this leap and bases this determination on Internal Revenue Code section 702, subdivision (b), which provides that the tax character of a tax item for a partner is determined as if it was incurred in the same manner as incurred by the partnership.

The FTB further explained that the execution of an agreement relinquishing control over the business is an exercise of the right of control over the partnership’s business, and business entities cannot escape being classified as doing business in California by using manager-managed LLCs. However, the FTB based this part of its legal ruling on case law holdings that were determining whether a partnership existed.

The FTB does point out the narrow exception in Appeals of Amman & Schmid FinanzAG, et al., 96-SBE-008, April 11, 1996. In Amman, the California State Board of Equalization held that limited partners of limited partnerships were not doing business in California even if the limited partnerships were doing business in California.

If a business entity was willing to fight the FTB, then there is litigable issue as to whether the business entity members of an LLC doing business in California could escape California filing requirements if the LLC’s operating agreement was drafted so as to give certain LLC members the same rights and restrictions as limited partners have under the Uniform Limited Partnership Act of 2008.

If a business willing is not willing to fight the FTB, then it would be recommended to follow the guidance in the Legal Ruling:

SITUATION 1 – LLC Only Registered To Do Business in California

LLC A:

LLC “A” is an LLC with two or more members, and is classified as a partnership for tax purposes. During a taxable year beginning on or after January 1, 2011, LLC A is registered to do business in California, but has no activities or factor presence in California sufficient to constitute “doing business” within the meaning of subdivisions (a) or (b) of Revenue and Taxation Code section 23101.

Does LLC A have a California return filing requirement and obligation to pay all applicable taxes and fees?

Yes. In this situation, LLC A has a California return filing requirement and is subject to the LLC tax and fee because it is registered to do business in California.

 

Member B:

Member “B” is a “corporation”22 that is a member of LLC A holding a 15 percent interest in LLC A. During the same taxable year beginning on or after January 1, 2011, Member B is not incorporated, organized, or registered to do business in California, and has no activities or factor presence in California sufficient to constitute “doing business” within the meaning of subdivisions (a) or (b) of Section 23101, and has no California source income.

Does Member B have a California return filing requirement and obligation to pay all applicable taxes and fees as a result of its membership interest in LLC A?

No. The fact that LLC A has a California return filing requirement and obligation to pay all applicable taxes and fees solely by virtue of registering to do business in California does not result in its member, Member B, also having a California return filing requirement and obligation to pay all applicable taxes and fees.

In this situation, Member B does not have a California return filing requirement and is not subject to the franchise tax as a result of its membership interest in LLC A, because LLC A’s act of registering to do business in California is not a transaction or activity for the purpose of financial or pecuniary gain or profit that is attributed to Member B.

 

SITUATION 2 – LLC Only Organized in California

LLC C:

LLC “C” is an LLC with two or more members, and is classified as a partnership for tax purposes. LLC C is organized in California within the meaning of paragraph (1) of subdivision (b) of Section 23101. During a taxable year beginning on or after January 1, 2011, LLC C has no other activities or factor presence in California sufficient to constitute “doing business” within the meaning of subdivisions (a) or (b) of Section 23101.

Does LLC C have a California return filing requirement and obligation to pay all applicable taxes and fees?

Yes. In this situation, LLC C has a California return filing requirement and is subject to the LLC tax and fee because it is organized in California.

 

Member D:

Member “D” is a corporation that is a member of LLC C holding a 15 percent interest in LLC C. During the same taxable year beginning on or after January 1, 2011, Member D is not incorporated, organized, or registered to do business in California and has no activities or factor presence in California other than through its membership in LLC C, and has no California source income.

Does Member D have a California return filing requirement and obligation to pay all applicable taxes and fees as a result of its membership interest in LLC C?

No. The fact that LLC C has a California return filing requirement and obligation to pay all applicable taxes and fees solely by virtue of organizing in California does not result in its member, Member D, also having a California return filing requirement and obligation to pay all applicable taxes and fees. Although being organized in California is considered “doing business” within the meaning of paragraph (1) of subdivision (b) of Section 23101, the act of organizing in California is not attributed to the LLC’s members for purposes of whether the members are “doing business” in this state.

In this situation, Member D does not have a California return filing requirement and is not subject to the franchise tax as a result of its membership interest in LLC C, because LLC C’s act of organizing in California is not a transaction or activity for the purpose of financial or pecuniary gain or profit that is attributed to Member D.

 

SITUATION 3 – LLC Commercially Domiciled in California

LLC E:

LLC “E” is an LLC with two or more members, and is classified as a partnership for tax purposes. During a taxable year beginning on or after January 1, 2011, LLC E is commercially domiciled in California within the meaning of paragraph (1) of subdivision (b) of Section 23101.

Does LLC E have a California return filing requirement and obligation to pay all applicable taxes and fees?

Yes. In this situation, LLC E is “doing business” in California within the meaning of Section 23101 because it is commercially domiciled in California; therefore, it has a California return filing requirement and is subject to the LLC tax and fee.

 

Member F:

Member “F” is a corporation that is a member of LLC E holding a 15 percent interest in LLC E. During the same taxable year beginning on or after January 1, 2011, Member F is not incorporated, organized, or registered to do business in California and has no activities or factor presence in California other than through its membership in LLC E.

Does Member F have a California return filing requirement and obligation to pay all applicable taxes and fees as a result of its membership interest in LLC E?

Yes. The term “commercial domicile” refers to the principal place from which the trade or business of the taxpayer is directed or managed. Put another way, the location of a taxpayer’s commercial domicile is based on activity; i.e., the location of the day-to-day management of the business. Therefore, because LLC E is commercially domiciled in California, one or more of its members are engaging in day-to-day management, which constitutes a transaction or activity in California for the purpose of financial or pecuniary gain or profit within the meaning of Section 23101. Because LLC E is classified as a partnership for tax purposes, this activity is attributed to each of LLC E’s members under general principles of partnership law, and thus, the members are “doing business” in California within the meaning of Section 23101. The members have a California return filing requirement and must pay all applicable taxes and fees.

In this situation, Member F is “doing business” in California within the meaning of Section 23101; therefore, it has a California return filing requirement and is subject to the franchise tax.

 

SITUATION 4 – LLC “Doing Business” in California

LLC G:

LLC “G” is an LLC with two or more members, and is classified as a partnership for tax purposes. During a taxable year beginning on or after January 1, 2011, LLC G has activities or factor presence in California sufficient to constitute “doing business” within the meaning of subdivisions (a) or (b) of Section 23101.

Does LLC G have a California return filing requirement and obligation to pay all applicable taxes and fees?

Yes. In this situation, LLC G is “doing business” in California within the meaning of Section 23101; therefore, it has a California return filing requirement and is subject to the LLC tax and fee.

 

Member H:

Member “H” is a corporation that is a member of LLC G holding a 15 percent interest in LLC G. During the same taxable year beginning on or after January 1, 2011, Member H is not incorporated, organized, or registered to do business in California and has no activities or factor presence in California other than through its membership in LLC G.

Does Member H have a California return filing requirement and obligation to pay all applicable taxes and fees as a result of its membership interest in LLC G?

Yes. Because LLC G is classified as a partnership for tax purposes and is “doing business” in California within the meaning of Section 23101, all of LLC G’s members are “doing business” in California, and thus have California return filing requirements and are subject to all applicable taxes and fees, because the attribute of “doing business” by LLC G is attributed to its members under general principles of partnership law.

In this situation, Member H is “doing business” in California within the meaning of Section 23101; therefore, it has a California return filing requirement and is subject to the franchise tax.

 

SITUATION 5 – “Manager-Managed” LLC “Doing Business” in California

LLC I:

LLC “I” is an LLC with two or more members, and is classified as a partnership for tax purposes. During a taxable year beginning on or after January 1, 2011, LLC I has activities or factor presence in California sufficient to constitute “doing business” within the meaning of subdivisions (a) or (b) of Section 23101. LLC I is a “manager-managed” LLC.

Does LLC I have a California return filing requirement and obligation to pay all applicable taxes and fees?

Yes. In this situation, LLC I is “doing business” in California within the meaning of Section 23101; therefore, it has a California return filing requirement and is subject to the LLC tax and fee.

 

Member J:

Member “J” is a corporation that is a member of LLC I holding a 15 percent interest in LLC I. During the same taxable year beginning on or after January 1, 2011, Member J is not incorporated, organized, or registered to do business in California and has no activities or factor presence in California other than through its membership in LLC I.

Does Member J have a California return filing requirement and obligation to pay all applicable taxes and fees as a result of its membership interest in LLC I?

Yes. Because LLC I is classified as a partnership for tax purposes and is “doing business” in California within the meaning of Section 23101, all of LLC I’s members are “doing business” in California, and thus have California return filing requirements and are subject to all applicable taxes and fees, because LLC I’s attribute of “doing business” is attributed to its members under general principles of partnership law. The distinction between “manager-managed” LLCs and “member-managed” LLCs is not relevant for purposes of determining whether members of an LLC classified as a partnership for tax purposes are “doing business” in California within the meaning of Section 23101.

In this situation, Member J is “doing business” in California within the meaning of Section 23101; therefore, it has a California return filing requirement and is subject to the franchise tax.

 

SITUATION 6 – California Sales Exceed the Sales Amount in Section 23101(b)(2)

LLC K:

LLC “K” is an LLC with two or more members, and is classified as a partnership for tax purposes. During a taxable year beginning on or after January 1, 2011, the sales in California of LLC K exceed the sales amount then applicable in paragraph (2) of subdivision (b) of Section 23101.

Does LLC K have a California return filing requirement and obligation to pay all applicable taxes and fees?

Yes. In this situation, LLC K is “doing business” in California within the meaning of Section 23101; therefore, it has a California return filing requirement and is subject to the LLC tax and fee.

 

Member L:

Member “L” is a corporation that is a member of LLC K holding a 15 percent interest in LLC K. During the same taxable year beginning on or after January 1, 2011, Member L’s distributive share of the California sales of LLC K, exceed the sales amount then applicable in paragraph (2) of subdivision (b) of Section 23101. However, Member L is not incorporated, organized, or registered to do business in California and has no activities or factor presence in California other than through its membership in LLC K.

Does Member L have a California return filing requirement and obligation to pay all applicable taxes and fees as a result of its membership interest in LLC K?

Yes. Member L is “doing business” in California because its distributive share of the California sales of LLC K, as provided by subdivision (d) of Section 23101, exceeds the sales amount then applicable in paragraph (2) of subdivision (b) of Section 23101. A separate reason Member L is “doing business” in California is because LLC K, which is classified as a partnership for tax purposes, is “doing business” in California under Section 23101. Because LLC K is treated as a partnership, its attribute of “doing business” in California is attributed to all of its members under general principles of partnership law. Thus, all of LLC K’s members are “doing business” in California; and therefore, have a California return filing requirement and are subject to all applicable taxes and fees.

In this situation, Member L is “doing business” in California within the meaning of Section 23101; therefore, it has a California return filing requirement and is subject to the franchise tax.