State & Local Tax Bulletin (January 2011)
California Franchise Tax BoardMere
of Disregarded Entity
Franchise Tax Nexus
a tax associate in
the San Francisco office of Pillsbury Winthrop
Shaw Pittman LLP.
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The Franchise Tax Board has concluded in Legal Ruling 2011-01 that ownership by a corporation of a disregarded entity doing business in California creates franchise tax nexus for the corporation.
The issue presented in Legal Ruling 2011-01 (the "Legal Ruling") is whether a corporate owner of a disregarded entity is subject to the California franchise tax if the disregarded entity is doing business in California. The Franchise Tax Board ("FTB") concluded that is indeed the case, even if the corporate owner conducts no separate California activities. The Legal Ruling addresses two factual situations.
Situation One involves an owner of a Qualified Subchapter S Subsidiary ("QSub"). The owner of the QSub is a corporation formed under the laws of a state other than California, and conducts no separate activities in California sufficient to constitute doing business for franchise tax purposes. The QSub was formed under the laws of a state other than California and is not registered to do business in California, but conducts sufficient activities in California to constitute doing business for franchise tax purposes.
Because California law treats the activities of a QSub as those of its owner, including for purposes of determining whether the owner is doing business,[fn. 1] the FTB ruled that the owner of the QSub is doing business in California by virtue of the QSub's California activities.
Situation Two involves an owner of a single-member limited liability company ("SMLLC") disregarded for income tax purposes. The owner of the SMLLC is a corporation formed under the laws of a state other than California, and conducts no separate activities in California sufficient to constitute doing business for franchise tax purposes. The SMLLC was formed under the laws of a state other than California and is not registered to do business in California, but conducts activities sufficient to constitute doing business within California.
The FTB ruled that the owner of the disregarded SMLLC is doing business in California because the activities of a disregarded SMLLC are treated in the same manner as a sole proprietorship, branch, or division of the owner under "check the box" regulations.[fn. 2] Since the activities of the disregarded SMLLC are sufficient to constitute doing business in California for franchise tax purposes, FTB concluded that those activities are likewise sufficient to create franchise tax nexus for the owner.
FTB also ruled that failure of the owner of the disregarded SMLLC to consent to California's taxing jurisdiction on FTB Form 568-LLC will not sever taxable nexus of the owner. FTB noted that the consent is solely a collection mechanism, a matter of administrative convenience, and does not alter the legal determination of whether the owner has franchise tax nexus.
The Legal Ruling also notes that the same conclusions set forth above are applicable to owners of disregarded entities not separately doing business in California, but are themselves the owners of other disregarded entities doing business in California.
- Cal.Rev.& Tax.Code § 23800.5(a)(2).[return to text]
- Proc.& Admin.Regs., § 301.7701-2(a); 18 Cal.Admin.Code, § 23038(b)-2(a).[return to text]
This material is not intended to constitute a complete analysis of all
tax considerations. Internal Revenue Service regulations generally
provide that, for the purpose of avoiding United States federal tax
penalties, a taxpayer may rely only on formal written opinions meeting
specific regulatory requirements. This material does not meet those
requirements. Accordingly, this material was not intended or written to
be used, and a taxpayer cannot use it, for the purpose of avoiding
United States federal or other tax penalties or of promoting, marketing
or recommending to another party any tax-related matters.
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