Do I really have to pay the State of California Annual Minimum Franchise Tax? Taxed When Taxes Aren’t Owed.

By Jennifer Felten

They say two things in life are a certainty …death and taxes.  A small company named Swart Enterprises, Inc. (“Swart”) found out the hard way how states are always trying to get more revenue via tax dollars.  If you haven’t heard about Swart, don’t feel too bad.  It is a small, family owned company incorporated in Iowa.  It operates a 60-acre farm in Kansas where it occasionally feeds cattle for beef sales in Nebraska.  Its headquarters and primary place of business are located in Iowa.  Swart does not have a physical presence, real or personal property, or any employees in the State of California.  They are not registered with the California Secretary of State in order to transact interstate business.  It must have been a big surprise when Swart was contacted by the California Franchise Tax Board demanding Swart to file a California corporate franchise tax return for the tax year ending June 30, 2010.  The minimum franchise tax due in California is $800.00.  Once the penalties and interest were added in, Swart had to pay $1,106.00.  Swart contested the demand and requested a refund.

Why did the California Franchise Tax Board demand Swart pay the tax?  In 2007, Swart invested in Cypress Equipment Fund XII, LLC (“Cypress”), becoming a member of the LLC.  This investment amounted to a 0.2 percent (0.2%) ownership interest.  Cypress is a manager-managed LLC, not a member-managed LLC.  Basically, in a manager-managed LLC, the members hire a manager to conduct the day to day business, as opposed to the members of the LLC conducting the day to day business.  California’s franchise tax is imposed on every corporation that is “doing business” within California, whether or not it is incorporated, organized, qualified, or registered under California law. (Rev. & Tax. Code,1 § 23151, subd. (a).) The phrase “doing business,” for purposes of the franchise tax, means “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” (§ 23101, subd. (a); see Cal. Code Regs., tit. 18, § 23101 (Regulation 23101).)

Swart timely filed a complaint seeking a tax refund and declaratory relief.  Swart argued that its 0.2% ownership as a passive (limited) member is not enough to prove Swart is “doing business” within California.  In addition, Swart argued it was not a founding member of Cypress and had no voting rights or influence during the founding of Cypress.  Therefore, they have always been a passive member of Cypress.  Since it is a manager-managed LLC, Swart does not influence the day to day operations.  Even if Swart was not passive, a 0.2% share is not enough to influence the other members of the LLC.  Both Swart and the California Franchise Tax Board entered motions for summary judgments.  The trial court entered an order granting Swart’s motion for summary judgment.  Swart was awarded a refund in the amount of $1,106.71.  On November 25, 2014, the notice of entry of judgment was served.  On January 16, 2015, the Franchise Tax Board filed a timely notice of appeal.

The appellate court also ruled in favor of Swart.  They found: “[w]e conclude Swart was not doing business in California based solely on its minority ownership interest in Cypress LLC. The Attorney General’s conclusion that a taxation election could transmute Swart into a general partner for purposes of the franchise tax, and that the business activities of Cypress can therefore be imputed to Swart, is not supported by citation to appropriate legal authority and, in our view, defies a commonsense understanding of what it means to be ‘doing business.'”

This article only gives the highlights of the case.  It does not go into many of the details.  If you feel like you are also having to pay a tax that you have no duty pay, you may want to research this some more.  At least for this very specific case, “taxes” did not win.

Upcoming Speaking Engagements:

For April 2017, Jennifer has the following speaking engagements:

Tri-County Escrow Association, Tuesday, April 11, 2017

Ojai Valley Board of Realtors, Wednesday, April 12, 2017

The Inland Gateway Association of Realtors, Tuesday, April, 18, 2017

Conejo Simi Moorpark Association of Realtors, Friday, April 21, 2017

Escrow Training Institute, Saturday, April 29, 2017


Jennifer Felten

Jennifer Felten, Esq., Relaw Ms. Felten specializes in representing both individuals and legal entities, providing representation and guidance on a variety of real estate related matters.  Relaw APC 699 Hampshire Road, Suite 105 Westlake Village, CA  91361 US Phone: (805) 265-1031 or email her at: jennifer@relawapc.com

 

For inquiries or questions about booking speaking engagements, please email info@relawapc.com.


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