LLCs and California Taxes
© Myles Law Firm, Inc. 2008
In 1994, the California Legislature passed the Beverly-Killea Limited Liability Company Act authorizing the formation, operation and regulation of limited liability companies in California. The concept of an LLC was first adopted in Wyoming in 1977 as a business entity combining the more favorable features of sole proprietorships, partnerships and corporations in one organization. In 1988, the Internal Revenue Service ruled that it would treat LLCs as partnerships for federal tax purposes. As a result, by 1994, the popularity of LLCs in other states caused the California Legislature to believe that the state would lose out on small businesses and small business opportunities unless it adopted an LLC statute.
Like corporations, LLCs must pay the annual minimum corporate tax, currently $800.00. Rev. & Tax. C. §17941. Unlike corporations, LLCs are subject to an additional annual “fee” on their income (the “LLC fee”). Rev. & Tax. C. §17942.
As originally enacted, the LLC fee applied to all income reportable to California, regardless of whether the income was earned in or outside California. In response to a trial court decision, in 2007 the Legislature amended the LLC fee to apply only to income “derived from or attributable to” California. Rev. & Tax. C. §17942. As the law now stands, in addition to the annual minimum tax, an LLC organized or registered in California must pay a fee of:
i) $900.00 if the total income from all sources derived from or attributable to California for the taxable year is $250,000.00 or more but less than $500,000.00.
ii) $2,500.00 if the total income is $500,000.00 or more but less than $1,000,000.00.
iii) $6,000.00 if the total income is $1,000,000.00 or more but less than $5,000,000.00.
iv) $11,790.00 if the total income is $5,000,000.00 or more.
“Total income from all sources derived from or attributable to” California is determined under the rules applied to sales taxes. For tangible personal property, a sale, and therefore income, is “in this state if” the property is delivered or shipped to a buyer in California or the property is shipped from California and the taxpayer is not taxable in the buyer’s state. Rev. & Tax. C. § 25135. Other sales, and therefore other income, is “in this state” if the income-producing activity is performed in California or performed both in and outside California, but the greater proportion of activity, based on costs of performance, is performed in California. Rev. & Tax. C. § 25136.
The LLC fee has been challenged on constitutional grounds in three lawsuits. The first of the lawsuits to be decided by the Court of Appeal is Northwest Energetic Services, LLC, 159 Cal.App. 4th 841 (2008). In this case, the Court held that former Section 17492 was unconstitutional as applied to a foreign LLC that was registered in California but did no business and had no contacts with California.
The other two cases challenging the LLC fee are still in the legal system. In Ventas Finance I, LLC v. FTB, the LLC is a foreign LLC doing business both in and outside California. In Bakersfield Mall, LLC v. FTB, the LLC is a foreign LLC doing business only in California.
In April 2008, the California Franchise Tax Board issued Notice 2008-2 adopting a procedure for payment of refunds for LLCs in the same position as Northwest Energetic Services, LLC. The Notice is online at:
The Northwest Energetic Services Court held that the LLC fee was unconstitutional as applied to the LLC, but did not hold that the LLC fee was unconstitutional on its face, and there has been no challenge to the LLC by a domestic LLC. However, the Northwest Energetic Services Court found that the LLC fee “more closely resembles a tax” than a fee. This decision may open the door to a challenge to the LLC fee by a domestic LLC.
Finally, there also has been no challenge to the annual minimum tax. This tax is paid by both corporations and LLCs, and remains in full force.