California Limited Liability Company Fee Found Unconstitutional

California currently imposes a fee on the gross receipts (rather than net income) of every California limited liability company (“LLC”), but a recent court decision means it's possible this gross receipts fee is unconstitutional in some cases. Taxpayers who own interests in LLCs that pay the gross receipts fee should consider using the Franchise Tax Board's protective claims procedure to preserve their right to any refund that may be available as a result of this decision.

Currently, California requires LLCs to pay an $800 annual fee regardless of whether the LLC actually has any net income. In addition to the $800 annual fee, the State also imposes a gross receipts fee on all LLCs that are either doing business in California or are registered with the California Secretary of State's Office. The gross receipts fee is based on the LLC's total gross receipts and can be up to $11,790 a year (for gross receipts of $5 million or more).

In the recent decision, Northwest Energetic Services, LLC v. Franchise Tax Board, the Superior Court of San Francisco County found the gross receipts fee unconstitutional. The taxpayer in that case was an LLC formed under Washington law. During the relevant period it had places of business in Washington and Oregon . It had no assets, sales, operations or employees in California. The LLC became liable for both the $800 annual fee and the gross receipts fee, because it registered with the California Secretary of State to qualify to do business in California. The court said that the fee based on the Washington LLC's out-of-state income was unconstitutional because the fee was actually a tax. To be constitutional, a state tax must be fairly apportioned based on the taxpayer's in-state and out-of-state activity. Because the gross receipts fee was not fairly apportioned, the court found it unconstitutional when applied to an LLC with no California income.

Because the court decision is not yet final, its full effect is unclear at this point. The Franchise Tax Board has until mid-May 2006 to appeal. Presently, there is another case pending in the San Francisco Superior Court, Ventas Finance I, LLC v. Franchise Tax Board, that we hope will address whether the gross receipts fee is invalid in its entirety or only to the extent it is computed on non-California income. (This is a critical question that remains after Northwest Energetic. ) We are following both cases closely.

Most LLCs have statutes of limitations open for taxable years 2003 through 2005. Because the total potential refund for these years for each LLC could be up to $35,000, plus interest, and because a number of businesses operate through multiple LLCs, a substantial refund could be available if the LLC fee is found to be unconstitutional. In response to the Northwest Energetic decision, the Franchise Tax Board has agreed to accept protective refund claims. This process will prevent the statute of limitations from closing on previously paid gross receipts fees.

We recommend that LLCs that have paid the gross receipts fee consider filing protective refund claims with the FTB for all gross receipts fees paid with respect to all years open under the statute of limitations.

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Please contact us if you have questions or want more information. Please note that the information contained in this article is not intended to provide legal advice. You should consult with an attorney and not rely on any information contained herein regarding your specific situation.