Another California Case Addresses an LLC’s Liability for the State’s Annual LLC Tax

By: Betsy Goldstein, SALT Manager

At a glance

• The main takeaway: If your LLC owns a non-managing, minority interest in a pass-through entity doing business in California, you may be subject to the state’s LLC tax.
• Assess the impact: When determining if your LLC is required to pay California’s LLC tax, you must consider your share, based on your profits interest, of the property, payroll and sales of any pass-through entity of which you are the owner.
• Take the next step: Aprio’s State and Local Tax (SALT) team can assist you to determine the most appropriate course of action, which may include filing a refund claim.

Schedule a free consultation today to learn more!

The full story:

Over the past few years, we have written several articles addressing whether a limited liability company (LLC) is doing business in California and therefore subject to the state’s annual $800 LLC Tax, based on owning a minority membership interest in another entity that is also doing business in California.[1] 

This month, we look at this issue yet again in a recent California Office of Tax Appeals decision that addresses a taxpayer’s 2013-2016 claims for refund of the $800 LLC tax.[2]

Some of the key facts in this case are as follows:

1. FPA Governor Park Associates, LLC (Associates) owned real property in California purchased at an original cost of $13 million.
2. Associates was wholly owned by FPA/PRIP Governor Park, LLC (FPA). 
3. During 2013 and 2014, FPA Governor Park Investors, LLC (Investors), held a 6.99 % profits interest, but a 52.35 loss and capital interest in FPA. During 2015 and 2016, Investors was the sole owner of FPA. Thus, FPA was taxed as a partnership for 2013 and 2014 and was treated as a disregarded entity for 2015 and 2016.
4. During 2013 – 2016, MJK Real Estate Fund II, LLC (the Taxpayer) held a 5.21% profit, loss and capital interest in Investors, and it was not the managing member of Investors.

Take a closer look at the case

For tax years beginning on or after January 1, 2011, a taxpayer is considered doing business in California and subject to the LLC Tax if (a) the taxpayer is actively engaging in any transaction for the purpose of financial or pecuniary gain or profit OR (b) if any of the following apply:

• Taxpayer is organized or commercially domiciled in California,
• Taxpayer’s California sales exceed the lesser of $500,000 or 25% of taxpayer’s total sales,
• Taxpayer’s California property exceeds the lesser of $50,000 or 25% of taxpayer’s total property, or
• Taxpayer’s California payroll exceeds the lesser of $50,000 or 25% of taxpayer’s total payroll.[3]

For purposes of determining the sales, property and payroll thresholds, a taxpayer that is an owner of a pass-through entity must include its pro-rata share from those pass-through entities.[4]

For the years at issue, there was not clear guidance on whether a profits interest or capital interest should be used for determining a taxpayer’s share from pass-through entities. In this case, for tax years 2013 and 2014, since Investors held a 6.99% profits interest and a 52.35% capital interest in FPA, the Taxpayer’s share of property exceeded the applicable threshold when the capital interest was applied ($13M * 52.35% * 5.21%) but not when applying the profits interest ($13M * 6.99% * 5.21%).[5] 

The OTA noted that effective January 1, 2019, Regulation 25137-1, which is used to determine the amount of California property, payroll and sales,[6] was amended to state that: “The taxpayer’s interest in the partnership shall be determined by reference to its interest in profits of the partnership.”[7] The OTA ruled that for years prior to that amendment, an owner’s share of property, payroll and sales from a partnership should be determined by reference to the owner’s profits interest. Therefore, in this case, the Taxpayer did not exceed the applicable thresholds for 2013 and 2014.

The OTA then turned to an analysis of whether the Taxpayer was doing business based on being “actively engaged” under section 23101(a). Based on the Taxpayer’s 5.21% interest in Investors and that it did not have any authority to manage the activity of Investors, the OTA concluded that the facts in the case are similar to those in Swart and Jali, and therefore, the Taxpayer was not doing business in California for 2013 and 2014.[8]

The bottom line

If your LLC owns a non-managing, minority interest in a pass-through entity that is doing business in California, it is important to analyze whether you should be filing and paying the California LLC Tax.

Aprio’s SALT team has experience with these rules and can assist you to determine the most appropriate course of action, which could include a refund claim. We constantly monitor these and other important state tax topics, and we will include any significant developments in future issues of the Aprio SALT Newsletter.

Contact Betsy Goldstein, SALT Manager, at betsy.tuck@aprio.com or Jeff Glickman, partner-in-charge of Aprio’s SALT practice, at jeff.glickman@aprio.com for more information.

This article was featured in the September 2022 SALT newsletter.

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[1] See articles from our November/December 2020, October 2019, and February 2017 SALT Newsletters.

[2] In the Matter of the Appeal of MJK Real Estate Fund II, LLC, OTA Case No. 19044718, May 26, 2022.

[3] Cal. Rev. & Tax Code §23101(a) and (b).  The sales, property and payroll threshold are indexed each year. You can obtain the thresholds for recent years by clicking here.

[4] Cal. Rev. & Tax Code §23101(d).

[5] For tax years 2015 and 2016, since Investors owned 100% of FPA, the Taxpayer’s share of property exceed the applicable thresholds, and thus, the Taxpayer was doing business in California.

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

[7] Cal. Code of Regulations § 25137-1(f)(4).

[8] Swart Enterprises, Inc. v Franchise Tax Board, F070922 (Cal. Ct. App. 5th Dist., 1/12/17); In the Matter of the Appeal of Jali, LLC, 2019-OTA-204P, OTA Case No. 18073414, July 9, 2019. Note that this type of analysis is not relevant for 2015 and 2016 since the Taxpayer exceeded the property threshold for those years.

Disclosure

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matter.