California is Out of Control

Published on: 17:33PM Aug 16, 2013

Since I practice in the state of Washington, I end up doing a fair amount of California business and personal tax returns. This is one of my least favorite states to deal with and a recent court case winding its way through the system highlights this even more.

In Swart Enterprises, Inc. v. Franchise Tax Board, the taxpayer was an Iowa corporation with a farming activities in Kansas and Nebraska. They also had various passive business investments including an .02% interest in a California LLC (Cypress) that acquired, held, leased and disposed of capital equipment in various states. This LLC had 435 members of which 384 members were out-of-state.

The Franchise Tax Board asserted that Swart had enough business activity through their .02% interest in the Cypress LLC to require the filing of a California LLC tax return. Normally LLC's filed as a partnership do not owe any state tax, however, California charges $800 simply for the privilege of filing a return. In addition, based upon the gross revenue of the LLC an additional fee is owed. Since Swart was a corporation, that particular fee would not apply, but they would owe the $800 filing fee plus interest and penalties plus paying a person to prepare the tax return.

This case is winding its way through the Court System and I hope that the taxpayers win. $800 may not be a lot of money, however, lets assume that Cypress, LLC generated income of $1,000,000 and based on the ownership held by Swart, this would generate $200 of income. Therefore, California is requiring them to pay $800 on $200 of income which is an effective tax rate of 400%.

If California is successful in winning this suit, they have another 383 out-of-state members that they can go after at $800 each per year or about $306,400 of additional filing fees plus interest plus penalties just for Cypress and I can guarantee that they will review every LLC filed in their state and start sending out notices even if you own .02% or less of the LLC.

Therefore, if you are farming operation in the Midwest, but you own some small passive LLC investment that is located in California, you may want to consider selling it before you get a notice from the Franchise Tax Board.