A common misperception is that an entity formed in a state other than California is not subject to tax by California, which is fueled by a considerable amount of advertising encouraging Californians to save taxes by incorporating out of state. In reality, where an entity is formed has no impact on how California taxes it. The Franchise Tax Board (FTB) has launched a publicity and enforcement campaign to increase the public’s awareness of how out-of-state entities are taxed in California.
If a legal entity such as a corporation, partnership, or limited liability company is doing business in California, California taxes applicable to that type of entity apply. A California C corporation will be subject to the California Franchise Tax on that part of its net income apportioned to or sourced in California. S corporations are subject to the 1.5 percent S corporation tax on their net income apportioned to or sourced in California. A limited liability company is subject to an annual fee of up to $11,790, depending on the amount of gross receipts it has from California sources, up to a maximum of $5 million. Corporations, limited partnerships, and limited liability companies also are all subject to a minimum tax of $800 per year if they are doing business in California.
California expanded its definition of “doing business” in 2011. An entity is doing business in California under any of the following circumstances:
- The entity actively engages in any transaction in California for the purpose of financial gain or profit.
- The entity is organized or commercially domiciled in California. The commercial domicile is the principal location from which the business is managed.
- The entity has California sales in excess of the lesser of $500,000 or 25 percent of its total sales.
- The value of the entity’s real property and tangible personal property located in California exceeds the lesser of $50,000 or 25 percent of the value of this property owned by the taxpayer.
- The entity’s California compensation paid exceeds the lesser of $50,000 or 25 percent of the total compensation paid.
The FTB provided an example of the expansive definition. A California resident, Paul, is a member of a Nevada LLC. The LLC owns property in Nevada for which it hires a Nevada management company to collect the rents, etc. Paul has the right to hire and fire the management company and occasionally speaks with the management company by telephone. From these facts, the FTB concluded that Paul is actively engaging in business transactions on behalf of the LLC for financial profit in California, and therefore the LLC is doing business in California.
Last year the SBE decided a case in which it determined that a Nevada corporation was doing business in California. In SUP, Inc. (SBE, November 14, 2012), the taxpayer was a Nevada corporation that served as the general partner of a Nevada limited partnership. All of the partnership’s assets and business activities were located in Nevada. Another general partner of the partnership was a California corporation with a California address. Because the partnership had a California-based general partner, the partnership was considered to be doing business in California through the activities of its general partner. And because the partnership was doing business in California, the Nevada corporation was also considered to be doing business in California and was liable for the minimum franchise tax, adding further credence to the maxim: “Choose your partners carefully.”
The LLC fee for 2013 must be estimated and paid by June 15, 2013, using Form 3536. The state can impose a penalty of $2,000 per taxable year if an entity from another state is doing business in California and does not properly qualify with the Secretary of State to do business and/or fails to file a tax return and pay the taxes and fees due. The penalty is due only if the FTB sends a written demand that a return be filed and the taxpayer does not file the return within 60 days. The penalty continues to apply if the entity’s powers are suspended or forfeited and is in addition to any other penalties for nonfiling or nonpayment.