Posted by: Robert Horwitz | July 19, 2021

An LLC “Doing Business” in California by GARY MARKARIAN and ROBERT HORWITZ

At one point or another, you may have heard that California has an $800 per year tax for businesses in California. But what is this tax and to which business does it apply to?

California has an annual franchise tax. Every corporation that:

  1. is incorporated under the laws of California;
  2. is qualified to transact intrastate business in California pursuant to Chapter 21 of Division 1 of Title 1 of the Corporations Code (this chapter applies to foreign corporations who register with the Secretary of State to transact intrastate business); and
  3. is doing business in California[1]

is subject to the minimum franchise tax and shall pay annually to the state a minimum franchise tax of eight hundred dollars.[2]

Beginning in 1997, limited liabilities companies (“LLC”) doing business in California were also required to pay annually to the state “a tax for the privilege of doing business” in California in the amount specified in Cal. Rev. & Tax. Code § 23153.[3]

The first two categories of corporations required to pay the annual franchise tax is straightforward – a corporation is or is not incorporated under the laws in California, or a corporation is or is not qualified to transact intrastate business in California.

But what does that mean for corporations not incorporated in California or not transacting intrastate business in the state? And for LLCs? When are those corporations or LLC’s “doing business” in California?

Generally, “’doing business’ means actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”[4] A taxpayer does business in California if any of the following conditions have been satisfied:

  1. The taxpayer is organized or commercially domiciled in this state;
  2. Sales in the state exceed the lesser of $500,000 or 25% of the taxpayer’s total sales;
  3. The real property and tangible personal property of the taxpayer in California exceed the lesser of $50,000 or 25% of the taxpayer’s total real property and tangible personal property; and
  4. The amount paid in California by the taxpayer for compensation exceeds the lesser of $50,000 or 25% of the total compensation paid by the taxpayer.[5]

The Office of Tax Appeals recently issued an opinion about the threshold limits of R&TC 23101(b)(3).

In the Matter of Consolidated Appeals of LA Hotel Investments

On May 13, 2021, the Office of Tax Appeals issued an opinion about whether two LLCs, La Hotel Investments #3, LLC (“Hotel #3”) and La Hotel Investments #2, LLC (“Hotel #2”), organized in the state of Louisiana were doing business in the state of California.[6]

Hotel #3 had a 5.41% interest in Irvine Center Hotels, LLC (“Irvine Center”), in 2013. Hotel #2 had a 2.56% interest in Tustin Gateway SPE LLC (“Tustin Gateway”), in 2013 and a 5.13% interest in both 2014 and 2015.  Both Irvine Center and Tustin Gateway were California LLCs that owned hotel properties in Orange County, California.  Hotel #2 paid the $800 franchise tax for 2013 and Hotel #3 paid the $800 franchise tax for 2013, 2014 and 2014.  Both LLCs filed refund claims for the franchise tax paid, stating that they were not doing business in California in those tax years and, therefore, were not subject to the annual $800 LLC tax.

The LLC’s pursued their refund claims based on the decision in Swart Enterprises, Inc. v. Franchise Tax Bd. (2017) 7 Cal.App.5th 497, which held that an out-of-state corporation’s passive holding of a 0.2 percent ownership interest in a manager-managed LLC doing business in California, with no right of control over the business affairs of the California LLC, was not itself doing business in California under R&TC section 23101(a).

The Franchise Tax Board argued that the LLCs were doing business in California because the LLC’s respective distributive share of the real and tangible property of Irvine Center Hotels and Tustin Gateway exceeded the thresholds stated in R&TC section 23101(b)(3).

For 2013, Irvine Center reported assets in California of $25,349,626. Based on Hotel #3’s 5.41% interest in Irvine Center, Hotel #3’s distributive share of Irvine Center’s property was $1,371,415, which exceeded the $50,000 threshold set forth in R&TC section 23101(b)(3).

For 2013, Tustin Gateway reported assets of $50,947,674. Based on Hotel #2’s 2.56% interest in Tustin Gateway, Hotel #2’s distributive share of Tustin Gateway was $1,304,260. In 2014 and 2015, Tustin Gateway reported assets of $51,434,471, and based on Hotel #2’s 5.13% interest in those years, Hotel #2’s distributive share for 2014 and 2015 was $2,638,588. Thus, Hotel #2’s distributive share of Tustin Gateway’s property for the three years at issue exceeded the $50,000 threshold as well.

The Hotel LLCs did not dispute the calculations discussed above, but rather argued they were not doing business in California within the meaning of R&TC section 23101(b) because Swart did not address R&TC section 23101(b).  They also argued that they were passive investors in Irvine Center and Tustin Gateway and “it seems a ’stretch’ to try to allocate a prorated percentage of

income and assets to passive investors.”  However, the Office of Tax Appeals found Swart inapplicable because the dispute in Swart concerned a tax year before enactment of R&TC section 23101(b) in 2010.

Based on the Hotel LLC’s distributive shares of property in Irvine Center and Tustin Gateway, the OTA found the two LLCs were doing business as defined by R&TC section 23101(b)(3) and were not entitled to a refund of the $800 LLC taxes paid.

Section 23101(b)(3) provides that a corporation or LLC is doing business in California if the “real and tangible personal property of the taxpayer in this state exceed the lesser of fifty thousand dollars ($50,000) or 25% of the taxpayer’s total real property and tangible personal property.”  Under California law, a partnership and an LLC is distinct from its partners and a member of an LLC or a partner in a partnership is not considered to own the real or tangible personal property of the business.[7]  Many non-residents own minority interests in California businesses and real estate partnerships through LLCs.  The OTA’s construction of the statute will have a major impact on these non-resident investors.  Will the FTB and the OTA push this decision to its logical limits and argue that out-of-state LLCs that own an interest in a California corporation are subject to the franchise tax if their proportionate share of the assets of the corporation exceed the $50,000 threshold?  If the LLC’s only asset is an interest in a California business, will it be subject to the franchise tax because the assets in California exceed 25% of its total property?  It seems that may be where we are heading.

Robert S. Horwitz is a Principal at Hochman Salkin Toscher Perez P.C., former Chair of the Taxation Section, California Lawyers’ Association, a Fellow of the American College of Tax Counsel, a former Assistant United States Attorney and a former Trial Attorney, United States Department of Justice Tax Division.  He represents clients throughout the United States and elsewhere involving federal and state administrative civil tax disputes and tax litigation as well as defending clients in criminal tax investigations and prosecutions. Additional information is available at http://www.taxlitigator.com.

Gary Markarian is an Associate Attorney at Hochman Salkin Toscher Perez P.C., and a graduate of the joint JD/LL.M. Taxation program at Loyola Law School, Los Angeles. While in law school, Mr. Markarian served as an intern at the Tax Division of the U.S. Attorney’s Office (C.D. Cal) and Internal Revenue Service Office of Chief Counsel’s Large Business and International Division.


[1] Cal. Rev. & Tax. Code § 23153(b)(1-3)

[2] Cal. Rev. & Tax. Code § 23153(d)(1)

[3] Cal. Rev. & Tax. Code § 17941(a)

[4] Cal. Rev. & Tax. Code § 23101(a)

[5] Cal. Rev. & Tax. Code § 23101 (b)(1-4)

[6] In the Matter of the Consolidated Appeals of: La Hotel Investments #3, LLC and La Hotel Investments #2, LLC, 2021 WL 2930331, at *1

[7] Cal. Corporations Code §§16201, 16203, 17300.


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