A questionable aspect of Legal Decision 2014-01 is the attempt to treat all types of LLC as identical. The specifics of manager-led LLCs are arguably directly relevant to whether their non-executive members operate in California. These members are like limited partners of a limited partnership and, as such, should be treated as limited partners under Amman & Schmid. Despite Amman & Schmid, FTB has consistently imposed minimum franchise tax and tax filing requirements on non-California companies that invest in California LLC, and issued deficiency notices to non-compliant companies, although FTB`s reasons for distinguishing Amman & Schmid were unclear. The FTB finally set out its reasons in Legal Judgment 2014-01, arguing that an investor in a California LLC – unlike a limited partner in a California limited partnership – does not automatically have a passive role in management as required by law. Instead, the investor`s management role depended on whether the LLC was run by managers or its members, and it was this element of choice that distinguished an LLC from a limited partnership. While non-state corporations disagreed with this approach, most simply paid the $800 franchise tax and filed returns because fighting the case wasn`t worth the legal fees (not to mention escalating tax arrears, penalties, and interest for non-compliance). Please contact one of the state and local tax lawyers listed below if you have any questions about FTB Notice 2014-01 or how it and related litigation apply to your situation. The FTB did not like Amman & Schmid for a long time and tried to limit it in the 2014-01 legal decision. While the decision was based on several factors, Legal Decision 2014-01 characterizes it as being based on the limited partners` inability to «manage or control the decision-making process of the company.» While this has some relevance to the analysis of members of member-managed LLCs, non-executive members of manager-led LLCs, such as sponsors, do not control the decision-making process of their LLCs.
Therefore, according to the FTB`s own reasoning, they should not be subject to reporting requirements or taxes. The FTB seeks to circumvent this by claiming that LLC members can «revoke» their delegation of administrative authority «at any time.» But the scope of such an authority varies from LLC to LLC and typically requires a majority vote of all members in California. According to the FTB`s logic, corporate shareholders also «manage» a company, because a majority of a company`s shareholders can lead to a change in management. But no one believes that corporate shareholders do business wherever a company is active. Ultimately, California courts will decide whether the FTB`s logic can be upheld. Despite the generally aggressive nature of Legal Decision 2014-01, there is one exception that actually benefits taxpayers. The decision states that LLC members who are only organized or registered in California, but who do not engage in actual business activities or the presence of significant factors, are not considered «business» in the state and are not required to file tax returns or pay taxes or fees on that basis. Accordingly, taxpayers should investigate the activities of the CLLs of which they are members. If tax returns were filed solely because the LLC was organized or registered in California, members may no longer need to file California tax returns and may be entitled to refunds of taxes or fees paid in previous years.
This can be especially beneficial in multi-level continuous flow entity structures. LLC members of such LLCs who receive communications or requests from FTB must indicate that they are not required to pay California LLC`s taxes or fees. In Legal Decision 2014-01 of July 22, 2014, the Franchise Tax Board (FTB) noted that an extrastate member of a limited liability company (LLC) «does business» in California1 when the LLC is taxed as a partnership and does business in California. As a result, the member must file an out-of-state tax return and pay taxes and fees in California, even if they have no other business in California. But the FTB based its decision on a flawed precedent and contrary to the current treatment of extra-state limited partners of a limited partnership. While the FTB has attempted to distinguish LLCs from limited partnerships, a review of their respective applicable laws reveals more similarities than differences, particularly with respect to manager-led LLCs. The FTB has taken an aggressive stance – it seeks to tax LLC members outside the state – but it`s unclear whether its position will be supported if it is challenged. The California Franchise Tax Board («FTB») issued a court decision in 2014-01 regarding the taxation of out-of-state members of limited liability companies classified as partnerships. The decision states that if such an LLC does business in California, its members must file California returns and pay all applicable taxes and fees, even if the members have no contact with California, other than membership in that LLC. According to its terms, Legal Decision 2014-01 is limited to LLC members who are business entities, but based on the FTB`s reasoning, it is not clear why business units are treated differently from individuals. The FTB`s position is questionable and has been the subject of an ongoing legal challenge in California Superior Court even before the decision was rendered.
However, non-compliance would result in penalties for members. Even if the Court of Appeal`s decision stands, non-state corporations should be cautious before taking the position, based on Swart, that they are not required to file returns or pay minimum tax. Swart clearly does not apply if the company actually has revenue from California, either through the LLC or other sources. Even if an outside state-owned company was only in contact with California as an investor in an LLC with operations in California, the Court of Appeals` decision was narrow and focused on the particular facts of the case, i.e., whether the non-state corporation had only a small stake in the LLC, under California law, the CLL was administered by managers (not its members). and the articles and operating agreement of the LLC gave the managers exclusive authority over the management of the LLC.