Understanding Taxation in California: Constantly Evolving Regulations

California’s tax regulations are complex and continually evolving, especially for Limited Liability Companies (LLCs) and Limited Partnerships (LPs), whether domestic or foreign. Staying current with these changes is essential for California residents and business owners to ensure compliance and avoid penalties. This article explores the current tax requirements for LLCs and LPs in California, focusing on the latest developments and key considerations for disregarded entities and out-of-state operations.

The Challenge of California’s Tax Landscape

California is notorious for its aggressive tax collection practices, often described as having "sticky fingers" when it comes to ensuring revenue from businesses operating within the state—even those formed elsewhere. This makes it crucial for business owners, including California residents with foreign entities like Arizona LPs, to understand their tax responsibilities.

California’s tax reach often extends beyond its borders. Under California Revenue and Taxation Code - RTC § 23101, entities that are considered "commercially domiciled" in California are subject to the state’s franchise tax and must file returns with the Franchise Tax Board (FTB). The code defines "commercially domiciled" as entities organized outside of California but having property, payroll, or sales in the state exceeding specific thresholds.

For instance, if a California resident owns an Arizona LP that holds investment property or conducts business in California, it may be deemed commercially domiciled and required to register with the Secretary of State. Failing to do so can result in penalties and interest charges from the FTB. Consulting a CPA who specializes in California tax law is advisable to navigate these intricate requirements.

Franchise Tax Requirements for LLCs and LPs

Both LLCs and LPs are typically required to pay an annual franchise tax in California, regardless of whether they are treated as disregarded entities. According to California Revenue and Taxation Code Section 17941 & Section 17935, LLCs and LPs must pay the minimum franchise tax of $800 each year, regardless of income or in-state activity. The only exception applies to those registered after January 1, 2021, which are exempt from the franchise tax in their first year of formation.

Disregarded Entities Owned by Another Entity

There is a common misconception that LLCs classified as disregarded entities do not need to file separate state tax forms or obtain their own EIN. However, under California Revenue and Taxation Code Section 18633.5, an LLC disregarded for federal tax purposes must still obtain an EIN and file Form 565 (Partnership Return of Income) with the state of California if it is owned by another entity (such as another LLC or LP). This ensures that the state can accurately track the LLC’s income and collect applicable taxes, even when federal tax treatment differs.

Best Practices for Compliance

Given California’s rigorous approach to taxation, businesses with ties to the state must remain diligent. Seeking professional advice from a qualified CPA  is essential for understanding specific requirements and avoiding costly mistakes. Timely registration, proper EIN acquisition, and the filing of required forms, such as Form 565, are fundamental steps to maintaining compliance.

References: 

https://codes.findlaw.com/ca/revenue-and-taxation-code/rtc-sect-23101/

https://www.ftb.ca.gov/forms/2023/2023-565-booklet.html

https://codes.findlaw.com/ca/revenue-and-taxation-code/rtc-sect-17935/#:~:text=(f)(1)%20Every%20limited,to%20the%20tax%20imposed%20under

https://www.law.cornell.edu/regulations/california/18-CCR-17942

Lodmell & Lodmell, PC is one of the nations leading Asset Protection Law Firms and the creators of The Bridge Trust®.  L&L serves clients nationwide and may be reached at [e-mail] or 602-230-2014.