Under California law, a limited liability company is a legally created entity that shields its members from personal liability and governs the operations of the company. LLCs are unique in that they have characteristics of both partnerships and corporations. LLCs are similar to partnerships in that members may participate in the management of the business. LLCs are also similar to corporations because, as previously mentioned, LLCs can shield members from personal liability.
California law, however, does not recognize LLC as an entity for tax purposes. To classify LLCs for tax purposes, California looks to the federal entity classification election system under the IRS guidelines. Under the federal regulations, “‘an eligible entity’ with two or more members is classified as a partnership unless it checks the box to be classified as an association.”
FTB Ruling Regarding Tax Classification of Business Entity Members in LLCs
The California Franchise Tax Board recently clarified tax issues relating to business entity members in LLCs. Specifically, the FTB posed the following question: “When is a business entity with a membership interest in a multiple-member limited liability company that is classified as a partnership for tax purposes, required to file a California return and pay any applicable taxes and fees?”
On 22 July 2014, the FTB issued Legal Ruling 2014-01 that certain business entity members in multiple-member LLCs are required to file California tax returns and pay taxes. A business entity member in an LLC must file a tax return and pay other fees when it is “doing business” in California.
Under California law, a taxpayer is “doing business” in California if it meets any of the following:
- A taxpayer is organized or commercially domiciled in California; or
- A taxpayer’s California sales, property, or payroll exceed the amounts then applicable under paragraphs (2), (3), or (4) respectively, of subdivision (b) of Section 23101.
In a partnership, California tax law imputes the business activities of each partner to the other partners, such when one partner is “doing business” in one geographic area any other partner is also “doing business” in that same area. The reasoning is that “a partner is recognized as deriving a share of partnership income and loss from the place where the partnership transacts its business.”
In its ruling, the FTB stated that when an LLC is treated as a partnership, “both the LLC and its members are subject to the same legal principles applicable to any partnership.” This means that for tax purposes, a business entity member is “doing business” in California and is subject to state tax filing and fee requirements. It does not matter if the LLC’s only connection with the state is that the LLC is registered to do business in the state.
The ruling stated that it does not matter whether the LLC is member-managed or manager-managed; the same principles apply.
The ruling provides several examples to explain its practical significance. Business entities with interests in LLCs should look to the FTB’s guidelines in determining whether it is necessary to file a California tax return and pay any fees. One example is below.
SITUATION 1 – LLC Only Registered To Do Business in California
LLC A:
LLC “A” is an LLC with two or more members, and is classified as a partnership for tax purposes. During a taxable year beginning on or after January 1, 2011, LLC A is registered to do business in California, but has no activities or factor presence in California sufficient to constitute “doing business” within the meaning of subdivisions (a) or (b) of Revenue and Taxation Code section 23101.
Does LLC A have a California return filing requirement and obligation to pay all applicable taxes and fees?
Yes. In this situation, LLC A has a California return filing requirement and is subject to the LLC tax and fee because it is registered to do business in California.
Contact Janathan L. Allen Regarding California Business Tax Issues or Questions
If you have any questions regarding the recent California FTB ruling or any questions regarding business entity formation and tax compliance issues, our experienced attorneys can help guide you. Contact one of our California offices.
