The California Franchise Tax Board is a government agency that is responsible for administering two of California’s major tax programs: Personal Income Tax and Corporation Tax. The FTB is tasked with administering California’s Revenue and Taxation Code and collecting taxes from individuals and businesses.
There is an inherent tension built into the relationship between California’s FTB and any taxpayer: the California FTB wants to collect as much tax as possible and the taxpayer wants to pay as little as possible under the law. With respect to its tax collection practices, the FTB states that it “should never try to overreach, and [tax administration] should be reasonable within the bounds of law and sound administration.”
The inevitable fact remains, however, that sometimes California’s FTB crosses the legal line of permissible tax collection practices by applying questionable interpretations of the Revenue and Taxation Code. When this happens, taxpayers may challenge the FTB’s tax collection practices as improper and beyond the scope of California’s Revenue and Taxation Code. A recent dispute between an Iowa corporation and the FTB shows how the FTB can sometimes overreach and how a taxpayer can challenge the FTB’s overreaching tax collection efforts.
Passive Membership Interest in LLC Is Not Subject to California Taxes
In Swart Enterprises Inc. v. FTB, Swart Enterprises, Inc. filed a complaint against the California Franchise Tax Board seeking a refund of more than $1,000 paid in taxes, interest, and penalties. Swart Enterprises is an Iowa corporation that does not have any business activities or physical presence in California. The company’s only connection with the state is that it invested $50,000 in a manager-managed California, LLC. Swart Enterprises’ investment represented about a .2% interest in the California LLC. Swart Enterprises has no authority to manage, control or take any part in the operation of the LLC. Its sole involvement is that of an investor.
As a result of Swart Enterprises’ interest in a California LLC, the FTB demanded that the company file a tax return for 2010. Swart Enterprises claimed, however, that it did not need to file a California tax return. Specifically, Swart Enterprises claimed that it was not subject to California’s $800 minimum franchise tax imposed on every corporation because it was not “doing business” in California. Swart Enterprises paid the tax under protest and filed a complaint against the FTB seeking an order that the company was not subject to California’s $800 minimum franchise tax.
The court agreed with Swart Enterprises that it was not “doing business” in California and not subject to the $800 franchise tax. The court stated that “passively holding an investment does not appear to constitute ‘doing business’ or [being] actively engaged in a transaction for gain or profit.” The court reasoned that Swart Enterprises was not “doing business” because the company had no interest in specific property of the California LLC; was not personally liable for the California LLC’s obligations; played no role in the California LLC’s management and had no right to do so; and could not act as an agent for the California LLC or bind it in any way. The FTB will likely appeal this decision.
Contact a California Tax Attorney
If you have questions regarding compliance with California’s tax laws, the experienced California tax attorneys at Janathan L. Allen, APC can help answer all your questions. Our California tax attorneys help individuals and businesses with a broad range of tax matters. Contact our California tax attorneys today for a free initial consultation.