THE OFFICE OF TAX APPEALS SOURCES AN INDIVIDUAL PARTNER’S DISTRIBUTIVE SHARE OF PARTNERSHIP GAIN USING CORPORATE APPORTIONMENT AND ALLOCATION RULES IN THE APPEAL OF SMITH

By Annie Rothschild¹

BACKGROUND

In recent years, the Office of Tax Appeals (OTA) and California courts have considered multiple cases addressing how owners of a pass-through entity source income from the pass-through. Each case considered whether the nonresident owners should use individual sourcing rules for sales of intangibles under California Revenue and Taxation Code (R&TC) section 17952 or corporate apportionment rules for nonresident income from a business, trade, or profession under California Code of Regulations ("CCR") section 17951-4.

First, in The 2009 Metropoulos Family Trust, et al. v. Franchise Tax Bd. (2022) 79 Cal.App.5th 245, the California Court of Appeal applied CCR section 17951-4(d) to source nonresident trust shareholders’ distributive shares of a unitary multistate S corporation’s gain on the sale of goodwill. The gain was business income and was apportioned, partially to California, using the S corporation’s apportionment factors. More recently, in Appeal of Buehler, 2023-OTA-215P, the OTA found that R&TC section 17952 applied to appellants’ receipt of gain for sale of their shares in a limited liability company ("LLC"). R&TC section 17952 applied because the appellants derived the income themselves through their direct ownership interest in the LLC-it was not income earned by the LLC and passed through to appellants as their distributive share.