PROCEED WITH CAUTION: Foreign Limited Liability Companies Holding California Property With Original Cost in Excess of $50,000 are Required to Pay $800 Annual Tax
California revised its definition for “doing business”, effective January 1, 2011, which may catch some inactive foreign (i.e. non-California) limited liability companies (“LLCs”) by surprise. The previous definition was fairly subjective and based on all the facts and circumstances. Prior to 2011, doing business was defined as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”1 This definition is found in the Revenue and Taxation Code under the area of the Corporation Franchise Tax, but is applicable to LLCs for purposes of determining whether they must pay the $800 minimum annual limited liability company tax..2
Effective for tax years beginning on or after January 1, 2011, section 23101 was amended to add a more specific standard, which includes the presumption that ownership of real property and tangible personal property in California, with original cost in excess of $50,000, is considered “doing business” in California. This is true whether or not the activity of the entity rises to the level of actively engaging in a transaction for the purpose of financial or pecuniary gain or profit.
It is common practice these days for LLCs to hold title to real estate. This might even be the case for some taxpayers who choose to hold their personal residence in a limited liability company. Many attorneys suggest using foreign LLCs for a variety of reasons, including operational, regulatory and cost differences. For example, the cost of forming a Delaware LLC is minimal, and Delaware also offers added legal protection and anonymity for the members.
For federal tax purposes, a single member LLC has no federal filing requirement as the entity is “disregarded” for tax purposes. However, California does require the filing of an LLC return, form 568, for a single member LLC, but only if it is organized in or registered to do business in California, or if it actually does business in California.
Before the aforementioned 2011 change in the definition of doing business, a foreign limited liability company holding California property, but not actually doing business, was not required to file the annual California return or pay the $800 tax.
This law change is somewhat of a sleeper, and might catch taxpayers, advisors and preparers off-guard. An unpleasant wake-up call may come in the form of a Notice and Demand as the Franchise Tax Board is now wielding its new-found weapon. Beginning January 1, 2013 the California Franchise Tax Board has been authorized to impose a $2,000 penalty on foreign or suspended LLCs that fail to file.3 The notice allows sixty days for the delinquent return to be filed before the penalty is imposed, but the penalty can also apply to years prior to 2013. Forewarned is forearmed.
To learn more about this issue and to learn more about HCVT, contact Karen Ritchie at (310) 566-6804 or firstname.lastname@example.org
1.California Rev. and Tax. Code section 23101(a).
2. California Rev. and Tax. Code section 17941(a).
3. California Rev. and Tax. Code section 19135.