Simplified Return Filing and Tax Payments for Partnership and Limited Liability Company Conversions¹

By Layton L. Pace²

EXECUTIVE SUMMARY

For each taxable year, California requires general and limited partnerships and limited liability companies ("LLC"s) classified as partnerships to file Franchise Tax Board ("FTB") Forms 565 and 568, respectively. The Instructions to each of those forms states to file two California returns if a conversion of a partnership into an LLC (or vice versa) happens on a date other than the last day of the year. This tax treatment conflicts with the Internal Revenue Service ("IRS") Form 1065 requirements that follow Revenue Ruling 95-37 and only require one return for the year.

The Franchise Tax Board’s position set forth in the Instructions creates confusion, cost and inefficiency for limited partnerships, LLCs, partners, members and the State because the position implies that the taxable year of the converting entity ends. As such, the conversion would require: (i) the entity to close its books and prepare two full complete short-year tax returns; (ii) the entity to issue K-1s to the owners for each short year; and (iii) the State to process and audit two fully completed tax returns. Moreover, the State’s interest in requiring two tax returns appears to be limited generally to collecting the $800 annual minimum tax from the converting entity.