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State of California Franchise Tax Board

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Jozel Brunett, FTB Chief Counsel.

California Return Filing Requirements for Members of Limited Liability Companies with Multiple Members, which are Classified as Partnerships for Tax Purposes

Questions have arisen regarding the legal basis for subjecting members of limited liability companies (LLCs) with multiple members, which are classified as partnerships for tax purposes, to a California return filing requirement and the imposition of applicable taxes and fees.

A creature of state law, every LLC is organized under a state statute that creates the entity, gives it a legal existence separate from its owners (i.e., its “members”), shields the members from partner-like vicarious liability, governs the company's operations, and controls how and when the entity comes to an end. LLCs are "hybrid" business entities in the sense that they have some of the characteristics of both partnerships (i.e., members typically have the right to participate in the management of the business similar to general partners of general or limited partnerships) and corporations (i.e., liability protection for the members analogous to shareholders of corporations).

Despite their existence under state statutory law, LLCs are not recognized as an entity choice for federal tax purposes. Thus, LLCs must be viewed differently for federal tax purposes than they are for state law purposes. Accordingly, tax questions involving LLCs and their members must be addressed by applying applicable tax law principles that flow from the entity choice the LLC makes for federal tax law under the federal entity classification election system[1] (commonly referred to as the "check-the-box" regulations), and not from state statutory law principles.

California tax law generally conforms to the federal entity classification election system by mandating that an eligible business entity be either classified or disregarded for California tax purposes, just as the entity is for federal tax purposes.[2] As a general matter, an LLC with two or more members is taxed as a partnership unless it elects to be taxed as a corporation.[3]   The federal check-the-box scheme determines the form of the business for tax purposes and all of the tax law consequences of that decision are based on the applicable analysis for the form of entity chosen. For example, if an LLC with two or more members chooses to be treated as a corporation for tax purposes, then its members will be treated as shareholders in that corporation for tax purposes. Conversely, if an LLC with two or more members does not check the box to be treated as a corporation for tax purposes, it is by default treated as a partnership for tax purposes, and its members will be treated as partners in that partnership for tax purposes.[4] The "doing business" analysis flows from this form of entity (for tax purposes) decision.

Subdivision (a) of section 23101, states that "'doing business' means actively engaging in any transaction for the purpose of financial or pecuniary gain or profit."[5]

In addition, for taxable years on or after January 1, 2011, an entity is "doing business" in California if:

  • It is organized or commercially domiciled in California,[6] or
  • Its sales, property, or payroll exceed the amounts then applicable under subdivisions (b)(2), (b)(3), or (b)(4) respectively, of section 23101.

The "doing business" analysis for partners of partnerships is not new in California. It is well established that the partners of a partnership are "doing business" in California if the partnership is "doing business" in California. In a narrow exception, in the Amman & Schmid Finanz decision, the California State Board of Equalization (the Board) held that a limited partner in a limited partnership is not "doing business" in California even if the limited partnership is "doing business" here.[7] The Board drew this distinction based on the conclusion that the general partner of a limited partnership has the rights, powers and restrictions of a partner in a general partnership, which include the right to manage and conduct partnership business, but limited partners do not. Acts of the general partner for that purpose bind the partnership, but a limited partner is not bound by the obligations of the partnership unless that partner is also named as a general partner or has participated in the control of the limited partnership's business. Given this analysis, the issue is one of management ability and control of the decision making process of the entity, not a question of limited liability.

FTB is currently in the process of drafting additional guidance for taxpayers in this area and we expect to be able to provide more information by the early part of 2014.

[1] See Entity Classification Election (IRS Form 8832).

[2] See, Cal. Rev. & Tax. Code, § 23038; see also Cal. Code Regs., tit. 18, § 23038(b)-3. 

[3] See Treas. Reg., §§ 301.7701-2(a) and 301.7701-3.

[4] In this context, the term "partnership" refers to a traditional partnership known as a "general partnership.” In a general partnership, all of the partners are "general partners," who have the right to manage and conduct partnership business.  

[5] It is important to note that having a California return filing obligation (and being subject to taxes and fees as a result of "doing business" in California under Cal. Rev. & Tax. Code, § 23101) is different than the requirement to register to do business in California with the California Secretary of State. The obligation to register with the California Secretary of State arises under the definition of "transacting intrastate business" in the California Corporations Code, which defines that term as, "… enter[ing] into repeated and successive transactions of business in this state, other than in interstate or foreign commerce.” (See Cal. Corp. Code §§ 191(a), former section 17001(ap), and 17708.03(a).) For more information, see the California State Board of Equalization's decision in the Appeal of Reitman Atlantic Corporation (2001) 01-SBE-002. For specific questions about the requirement to register to do business in California, taxpayers should contact the California Secretary of State.

[6] See Cal. Rev. & Tax. Code, § 23101(b)(1).

[7] Appeals of Amman & Schmid Finanz AG, et al. (1996) 96-SBE-008.

Jozel Brunett
Chief Counsel

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