by LLC attorneys Richard C. Keyt, JD, MS (accounting), and Richard Keyt, JD, LL.M. (federal tax law)
The California Franchise Tax Board (FTB) states that a limited liability company taxed as a partnership is required to:
- Pay an annual minimum tax of $800.
- Pay an annual fee the amount of which depends on the LLC’s income from all sources attributable to orderderived from California.
- File California Franchise Tax Board Form 568 (LLC Return of Income).
The above requirements apply if any of the following applies to an LLC:
- The LLC is formed in California.
- The LLC registered with the California Secretary of State to transact business in California.
- The LLC was not formed in California (a “foreign LLC”), but it does business in California (see Revenue & Taxation Code Section 23101 for the definition of “doing business in California”).
Note: Doing business in California is not necessarily the same as transacting intrastate business. See “When Is a Person or Entity Doing Business in California?”
You would think that an LLC formed outside California would have to actually have a presence in California before it would be “doing business” in California. Unfortunately, the money-starved State of California takes a much broader view of doing business in California, which means that many LLCs formed outside California are unknowingly doing business in California and are therefor subject to the $800 minimum tax, the gross receipts tax, filing Form 568 and paying California income tax.
Example 1: Homer Simpson is a resident of California and a member of an Arizona LLC called “World Wide Widgets, LLC.” The Arizona LLC owns real estate in Arizona. The LLC hires an Arizona property management company to collect rent and maintain the property. Homer has the power to hire and fire the property manager. From time to time Homer calls the property manager about the property. Homer is ultimately responsible for the LLC’s assets.
This example is Example 1 on page 4 of the FTB’s General LLC Information Form 3556.
The FTB requires World Wide Widgets, LLC, to file FTB Form 568 and pay California state income tax because Homer, while a resident of California, acted on behalf of the foreign LLC. The FTB takes the position that a foreign LLC does business in California if any member, manager or agent of the foreign LLC conducts business in California on behalf of the foreign LLC.
FTB’s Statements on Doing Business in California
California defines doing business as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit” (R&TC Section 23101(a)). An LLC is “doing business” if any of the LLC’s members, managers, or agents performs activities in California on behalf of the LLC, regardless of where the LLC otherwise conducts business. In addition, an LLC is “doing business” in California under R&TC Section 23101(a) if it is a nonregistered foreign LLC that is a member of an LLC classified for tax purposes as a partnership) that does business in California.
For tax years that begin on or after January 1, 2011, an LLC, is also doing business in California if any of the following apply:
- Sales as defined in subdivision (e) or (f) of R&TC Section 25120, including sales by the taxpayer’s agents and independent contractors, in California, exceed the lesser of$500,000 or 25 percent of the LLC’s total sales.
- Real or tangible property in California exceed the lesser of $50,000 or 25 percent of the taxpayer’s total real and tangible property.
- The amount paid in California for compensation, as defined in subdivision (c) of R&TC Section 25120, exceeds the lesser of $50,000 or 25 percent of the total compensation paid by the taxpayer.
The FTB may increase the above dollar amounts each year. For the preceding conditions, the sales, property, and payroll of the taxpayer include the taxpayer’s pro rata or distributive share of the sales, property and payroll of pass-through entities such as entities classified as partnerships for income tax purposes. (R&TC Section 23101(d)).
Here some additional examples from FTB Form 3556 of which a foreign LLC is doing business in California.
Example 2: Rachel is a California resident and member of an Oregon LLC. The Oregon LLC has a retail store in Oregon. Rachel uses a California address for the LLC’s tax filings and a California accountant to prepare the LLC’s tax returns. Rachel conducts business in California on behalf of the LLC. The LLC must file Form 568.
Example 3: Sarah is a California resident and a member of a Texas LLC. The Texas LLC receives royalties from Texas oil wells. Sara maintains a California business bank account and secures financing in California for the LLC’s Texas investments. Sara conducts business in California on behalf of the LLC. The LLC must file Form 568.
The problem with Examples 2 and 3 is that each contains two different acts instead of one. Query: Is FTB saying a foreign LLC must engage in two acts inside California before it is deemed to be doing business in California? We suspect that the FTB would say that one act in California is sufficient to cause the foreign LLC to do business in California.
FYI: LLCs classified as corporations should refer to FTB Publication 1060, Guide for Corporations Starting Business in California. This publication provides information for these types of LLCs.