California May Owe Refunds to Out-of-State LLCs

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By Laura Mahoney

California tax officials won’t appeal an appellate court ruling that an out-of-state corporation with a small interest in a California investment fund doesn’t owe the state’s $800 minimum franchise tax.

The Franchise Tax Board’s decision to let a lower court ruling stand on the matter means the board may owe millions of dollars in refunds to limited liability companies that have been waiting for a final outcome in the case ( Swart Enters., Inc. v. Cal. Franchise Tax Bd. , Cal. Ct. App., No. F070992, 1/12/17 ).

The tax board will provide information to taxpayers soon in light of the decision, FTB spokesman Chris Smith told Bloomberg BNA Feb. 22.

Although the tax at issue in the case is only $800 plus interest and penalties, the FTB has been issuing notices to taxpayers in similar situations saying they owe $2,000 to $3,000 while the case has been pending, according to an attorney for Swart Enterprises Inc., the plaintiff. Many of those taxpayers have filed refund claims.

“It’s been a long road,” Amy Silverstein, with Silverstein & Pomerantz LLP in San Francisco, told Bloomberg BNA.

No Physical Presence

The FTB’s decision not to appeal to the California Supreme Court signals that it is dropping its argument that the Iowa-based corporation with a 0.2 percent ownership interest in a California fund owed the minimum franchise tax.

A three-judge panel for the California Court of Appeal ruled in favor of Swart in January, saying the company has no physical presence and isn’t doing business in the state. The trial court also ruled in favor of the company, which operates a 60-acre farm in Kansas.

Swart invested $50,000 in 2007 in a California investment fund that later elected to be taxed as a partnership for state and federal income tax purposes. The FTB has so far unsuccessfully argued in court that because the fund elected to be treated as a partnership, it was doing business in California and so was Swart.

FTB Guidance

Now that it isn’t continuing to litigate the case, the FTB must address a legal ruling that it issued while the case was pending in its forthcoming information to taxpayers, Steve Wlodychak, a principal at Ernst & Young LLP who focuses on state, local and federal tax issues, told Bloomberg BNA.

In FTB Legal Ruling 2014-01 issued July 22, 2014, the tax agency addressed facts similar to those in the Swart case, saying tax liabilities and filing obligations for LLCs aren’t dependent on whether they have delegated management authority to another party. The FTB ruling isn’t consistent with the court ruling that members of managed LLCs in which investors have no say don’t owe California tax, Wlodychak said.

The FTB said in the notice the tax liability for LLCs depends on whether they elect to be treated as corporations or partnerships and whether they are doing business in the state.

To contact the reporter on this story: Laura Mahoney in Sacramento, Calif., at LMahoney@bna.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bna.com

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