Individuals and entities, including those from outside California, who invest in or do business through an out-of-state limited liability company (“LLC”) may be surprised to find out that they have filing obligations and tax liabilities in California as a result of California’s far-reaching rules and interpretations related to when an LLC is treated as “doing business” in California.
Under California law, all LLCs are required to annually file a California tax return and pay at least an $800 California franchise tax if they:
- Engage in any transaction in California for the purpose of financial gain or profit.
- Are incorporated or organized in California.
- Have qualified or registered to do business in California.
- Are “doing business” in California, whether or not they incorporated, organized, qualified or registered under California law.
The Franchise Tax Board (“FTB”) takes the position that an LLC organized in a jurisdiction outside California is nevertheless “doing business” in California if:
- It is a member of an LLC that does business in California.
- It is a general partner in a partnership that does business in California.
- Any of the LLC’s members, managers, or other agents conducts business in California on behalf of the LLC.
In addition, an out-of-state LLC is “doing business” in California if:
- The LLC is commercially domiciled in California (i.e., California is the place where realistic control of the LLC’s functions is centered).
- Sales, including sales by the LLC’s agents and independent contractors, in California exceed the lesser of $500,000 or 25% of the LLC’s total sales.
- Real or tangible property of the LLC in California exceeds the lesser of $50,000 or 25% of the LLC’s total real and tangible property.
- The amount paid in California by the LLC for compensation exceeds the lesser of $50,000 or 25% of the total compensation paid by the LLC.
For purposes of these calculations, the sales, property and payroll of the LLC include the LLC’s pro‑rata or distributive share of any pass‑through entities (i.e., partnerships, LLCs and S‑corporations).
Some examples that may surprise you:
- A Nevada LLC acquires a passive minority membership interest in a Delaware LLC that owns and operates several California shopping centers. The Nevada LLC may be treated as “doing business” in California simply by reason of its ownership of a membership interest in the Delaware operating LLC, resulting in the Nevada LLC’s own California tax filing obligations.
- A Montana LLC owns an apartment building in Montana that is managed by an on-site (Montana) property manager. One of the three LLC managing members is a California resident. The Montana LLC may be treated as “doing business” in California simply by reason of the existence of a California managing member.
The State can impose a penalty of $2,000 per taxable year if an out-of-state LLC is doing business in California and 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 LLC does not file the return within 60 days.
Also, any contract made by an out-of-state LLC in California that is neither qualified to do business nor has a corporate account number from the FTB is voidable by any other party to that contract for the period during which the out-of-state LLC fails to file a tax return required by the FTB.
Note that the FTB’s determination of when an out-of-state LLC must file tax returns is in contrast with the California Corporations Code. Under the California Corporations Code, any entity that “actively engages in any transaction in California for the purpose of financial gain or profit” must register with the California Secretary of State. But for this purpose, an out-of-state corporation is not considered to be transacting business in California merely because it is a member or a manager of a domestic or out-of-state LLC or a limited partner of a domestic or out-of-state limited partnership. Moreover, the new California Revised Uniform Limited Liability Company Act, effective as of January 1, 2014, provides that an out-of-state LLC “may” register in California and does not impose penalties for failing to do so.
Non-residents of California are also not necessarily off the hook for California taxes arising from ownership of an LLC. Such non-residents may owe taxes on pass-through income sourced from an LLC’s California activities despite their non-resident status.
BOTTOM LINE: Your out-of-state LLC may have nexus and filing obligations in California and taxes may be owed for such LLC’s activities in California!