On Oct. 19, 2018, the California Franchise Tax Board (FTB) modified Legal Ruling (LR) 2014-01 by issuing LR 2018-01. LR 2014-01 (July 22, 2014) originally provided guidance on applying California’s ‘doing business’ rules and related $800 minimum tax, for business entities with membership interests in multiple-member limited liability companies (LLCs).
LR 2018-01 modifies existing LR 2014-01 to reflect the FTB’s application of the 2017 Swart decision (Swart Enterprises, CA Super Ct. No. 13CECG02171, Jan. 12, 2017). After LR 2014-01 was issued, a California Appellate Court decision in Swart held that a non-California S-corporation with a 0.2 percent interest in a manager-managed California LLC was not “doing business” in California and was not subject to the $800 minimum tax. FTB Notice 2017-01 was issued (Feb. 28, 2017) to inform taxpayers of the Swart decision and that the FTB would not file an appeal. To read more about Swart, please read our tax alert titled "Franchise tax did not apply to ownership interest in California LLC".
LR 2018-01 modifies LR 2014-01 at paragraph one on page four, and paragraph three on page 10, to state that members of an LLC are themselves “generally considered” to be “doing business” in California. The language was also added to LR 2014-01 indicating that a narrow exception may apply in limited circumstances, citing both Swart and FTB Notice 2017-01.
The FTB has demonstrated a strict interpretation of the Swart decision in response to taxpayers asserting that they are not “doing business” in California. The FTB has issued letters to these taxpayers, stating that the FTB will follow the Swart decision for taxpayers with the same facts. The FTB letter also requests specific information, as follows:
- List the name(s) and identification number(s) of the LLC(s) doing business in California in which you own equal or less than 0.2 percent membership interest. Please specify the membership interest percentage in each LLC.
- What date(s) did you acquire your membership interest in the LLC? If multiple interests were acquired, please list the date(s).
- Was the LLC(s) manager-managed (i.e., the LLC’s members delegated to a manager the authority to manage and control the LLC)? If yes, what date did the LLC become manager-managed? If multiple LLCs are involved, please list the date the LLC became manager-managed for each LLC involved.
Taxpayers should consider whether they can rely on the Swart decision when determining if the taxpayer’s interest(s) in LLCs will be deemed to be ‘doing business in California, thus subjecting the taxpayer to the California minimum $800 franchise tax. The FTB appears to take a strict interpretation of Swart and will be questioning taxpayers asserting similar facts.