Legal Ruling 2014-01: The FTB’s House of Cards
Rachelle H. Cohen
Rachelle Cohen is an attorney with Kehr, Schiff & Crane LLP. Her practice focuses on assisting clients with their business transactions. Rachelle is the Chair of the California State Bar’s Partnerships and Limited Liability Companies Committee. She speaks frequently and has written about limited liability company and partnership issues.
In Legal Ruling 2014-01, dated July 22, 2014, the Franchise Tax Board (FTB) determined that an out-of-state member of a limited liability company (LLC) is "doing business"1 in California if the LLC is taxed as a partnership and doing business in California. Accordingly, the out-of-state member must file a return and pay taxes and fees in California even if it otherwise has no activities in California. But the FTB based its ruling on precedent that is shaky and at odds with the current treatment of out-of-state limited partners of a limited partnership. Although the FTB tried to distinguish LLCs from limited partnerships, a look at their respective governing laws shows more similarities than differences, especially with respect to manager-managed LLCs. The FTB has taken an aggressive position–trying to tax out-of-state members of LLCs–but it is not clear that its position will be supported if challenged.
The federal Internal Revenue Code classifies LLCs as partnerships for tax purposes, absent an affirmative election to be taxed as a corporation.2 A partnership is taxed as a pass-through entity, whereby each partner is taxed on its distributive share of the partnership’s income, gains, losses and deductions.3 California’s Revenue and Taxation Code expressly follows the scheme set forth in the Internal Revenue Code.4