Why Your LLC May Be Doing More Than You Think In California Even When It’s Doing Nothing

Until two years ago, determining whether a company was “doing business” in California depended upon whether it was “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit”.  Cal. Rev. & Tax. Code § 23101.  While this is a very open-ended definition, the statute at least required that a taxpayer be actively engage in a transaction.  Requiring activity makes sense because the gerund clause ”doing business” necessarily implies action.  Can you really be “doing something [i.e., business]” when you are “doing nothing”?

In 2009, however, the legislature decided to expand the statute ostensibly to “to clarify and specify that companies that operate in the state or make sales in the state are doing business in California and subject to California tax.” AB 15XXX (Krekorian), Senate Floor Analysis, Feb. 14, 2009.  For tax years beginning on or after January 1, 2011, a taxpayer is considered to be doing business even when it does not actively engage in a transaction.  For example, the statute now provides that a taxpayer is doing business in California if “The real property and tangible personal property of the taxpayer in this state exceed the lesser of fifty thousand dollars ($50,000) or 25 percent of the taxpayer’s total real property and tangible personal property.”  Cal. Rev. & Tax. § 23101(b)(3).  In other words, simply owning property in California can constitute “doing business”.  The amendment requires the Franchise Tax Board to revise the $50,000 threshold annually and includes other triggers for doing business in California.

This changes affects out-of-state corporations and pass-through entities (partnerships, S corporations, limited liability companies treated as partnership).  Prior to the amendment, some of these entities may not have been “doing business” in California.  Now, these entities must file the appropriate tax return and pay the appropriate tax and fees.  If the entity is an LLC, its members may also be considered doing business in California.  See 60 Acres And A Lawsuit Challenging The FTB’s Interpretation of “Doing Business”.

The statute is an obvious attempt to increase revenue by reaching into the pockets of businesses that really have no business in California.  As with many attempts to increase revenue, this statute likely hurts California by discouraging the ownership of assets in the state.

 


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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