California—Refund of LLC tax

The State Board of Equalization recently ruled that a California LLC that filed a certificate of cancellation with the Secretary of State’s office within six months of filing its articles of organization and within four months of paying its annual $800 LLC tax was ineligible for a refund of the LLC tax. The SBE noted that a California LLC is liable for the tax unless its tax year was less than 15 days or if it (1) files a final annual state tax return for the preceding year; (2) does not do business in California after the end of the tax year for which the final return was filed; and (3) files a certificate of cancellation within twelve months of filing its final state tax return. Since the LLC’s tax year was more than 15 days and it did not have a prior year return, the SBE concluded that neither exception applied and thus no refund was due. Appeal of DG Resource LLC, SBE, Case No. 575594 (Nov. 14, 2012, released Mar. 7, 2013) (not to be cited as precedent).

Observation: As noted previously, California is stepping up enforcement of tax payments required to be paid by PTEs, particularly LLCs.

California—15-day rule; entity conversions

A business entity is not subject to the $800 annual/minimum tax if the entity did not conduct business in the state during the tax year, or its tax year was 15 days or less. California law operates to provide relief to business entities (LPs, LLPs, LLCs, and corporations) from the general requirement to pay the annual/minimum tax. For purposes of corporations, if the rule qualifies for the short-year 15-day rule, this period of time will also be disregarded for purposes of determining the corporation’s first year minimum tax waiver. A converting entity ends its tax year on the date of conversion, while the converted entity does not begin its tax year until the next day. The 15- day rule does not normally apply to entities involved in a conversion, because they are usually continuously doing business during both periods involved, so both the converting and converted entity each have a filing requirement. For newly formed LLCs, the $800 annual tax payment is due and payable by the 15th day of the fourth month after the LLC registers with the California Secretary of State or the date it begins doing business, if business begins before it registers with the California Secretary of State. Any portion of a month is considered a full month for calculating the annual tax payment due date. California FTB Tax News (Nov. 1, 2012).

Illinois—Taxpayer not investment partnership (thus, subject to replacement tax)

The Illinois Department of Revenue held that a taxpayer was not a qualified investment partnership because more than 10 percent of its income came from lottery winnings. The taxpayers created a partnership that collected and distributed Illinois lottery winnings and invested winnings and paid taxes on all winnings and investment income on an individual level. The Illinois Income Tax Act provides that partnerships are not subject to regular Illinois income tax, but that partnerships other than “investment partnerships” are subject to the so-called personal property tax replacement income tax. The Department noted that since more than 10 percent of the partnership’s income resulted from lottery winnings, the partnership is not a qualified investment partnership and nothing in the Illinois Income Tax Act exempts lottery winnings or qualifying investment securities received by a partnership from taxation. Illinois Dep’t of Rev., General Information Letter No. IT 12-0032-GIL (Dec. 3, 2012).

Observation: A number of states, either by statute or regulation, exempt qualified investment partnerships from their nonresident partner withholding or composite return regimes, but as illustrated above, each criteria for qualification must be met. Most QIP definitions require a substantial percentage of the income to be passive, investment-type income such as interest and dividends.

Tennessee—Franchise/excise treatment of not-for-profit LLC

An LLC that was exempt from federal income tax purposes under IRC § 401(a) was considered a not-for-profit entity for Tennessee franchise and excise tax purposes and therefore generally was not subject to either tax. Nevertheless, as a not-for-profit entity, the taxpayer was subject to the Tennessee excise tax to the extent its net earnings constituted unrelated business taxable income, as defined in IRC § 512, or were otherwise subject to income taxes under IRC Subchapter A. In addition, the taxpayer was subject to the Tennessee excise tax on all net earnings attributable to any activities unrelated to, and outside, the scope of the activities that gave it exempt status. The taxpayer was also subject to Tennessee franchise tax with respect to Tennessee net worth, or real or tangible personal property owned or used, attributable to activities subject to income tax under IRC § 512 (“UBTI”) or any other provision of IRC Subchapter A. The taxpayer was also subject to franchise tax attributable to activities unrelated to and outside the scope of the activities that gave the taxpayer its exempt status. Tennessee Letter Ruling No. 12-26 (Nov. 14, 2012, released Jan. 8, 2013).

Co-author - Patrick Smith, Director Baker Tilly Virchow Krause, LLP

Mr. Ely is a partner and Messrs. Thistle and Rhyne are associates with the multistate law firm of Bradley Arant Boult Cummings LLP in its Birmingham, Alabama office. Mr. Ely is Chair of the firm’s State & Local Tax Practice Group. Messrs. Ely, Thistle, and Rhyne co-author a chapter on the state taxation of PTEs in the treatise “Keatinge, Conaway and Ely on Choice of Business Entity” (West). Mr. Smith is the Tax Director at Baker Tilly Virchow Krause, LLP and is head of State & Local Tax Services for the firm’s Chicago office. Mr. Smith is a co-author of “State Taxation of Pass-Through Entities and Their Owners,” a treatise published by Warren Gorham and Lamont/West since 2005. Messrs. Ely and Smith have co-presented on this topic at NYU’s Institute on Federal Taxation, as have Messrs. Thistle and Smith for a webinar hosted by Strafford Publications in early June.