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SALT TALK: California Minimum Franchise Tax Refund Opportunity – May the Swart [1] Be With You

Posted by Wayne Berkowitz CPA, J.D., LL.M. on Mar 6, 2017 11:00:00 AM
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Here is how the conversation usually goes at Berdon: 

Berdon Person Other Than Me (“BPOTM”): Wayne, I have a client whose only connection to California is a 0.001% non-managing membership interest in manager-managed LLC.  The LLC is doing business in California.  Do I have to pay the $800 minimum franchise tax?

Me:  Well, there is a case with a limited partnership and similar facts that says you don’t have to.  But the Franchise Tax Board (“FTB”) has been interpreting it very narrowly and only applies the case to LPs and not LLCs.

BPOTM:  Wayne, that’s crazy.  The facts and circumstances are exactly the same.  Why should my client have to pay $800 and why should we go to the expense of filing the return?

Me:  Well, I agree with you, but you should explain to your client that the FTB is likely to send a notice indicating that tax is due and ultimately issue an assessment.  In order to clear this up, the cost is likely to exceed $800.  I sympathize, and if it was my own return I would seriously consider not filing, but we need to make a practical business decision here.

BPOTM:  I hear you.  I’ll speak to my client and help them make a decision on how to deal with this nuisance.

Now that the FTB has agreed not to challenge the Court of Appeal Decision in Swart Enterprises, Inc. v. Franchise Tax Board [2], I may never have this conversation again.  In Swart, the taxpayer’s only contact with California was a 0.2% non-managing LLC interest in an entity doing business in California.  The Fifth Appellate District ruled for the taxpayer and held they were not doing business in California and were entitled to a refund of the $800 minimum franchise tax.

While the FTB has been “warned” by the Courts in the past on this topic, in its infinite wisdom, they have applied existing jurisprudence very narrowly.  Way back in time, 1997 to be exact, the FTB agreed to acquiesce to the taxpayer victory in Appeal of Amman & Schmid Finanz AG [3], which held that a limited partner is not considered to be doing business in California simply because it holds an interest in a limited partnership that does business in California.  Yet the FTB refused to, until now, apply the exact same logic to LLC interests.

Why did it take twenty years to fix this problem?  Well, see the conversation, above.  How many taxpayers are going to take the time and expense needed to fight the FTB over an $800 nuisance.  The good news is California’s statute of limitations for filing a refund claim is generally four years from the date the return was filed (most jurisdictions are limited to three years).  A refund claim should be fairly straightforward and certainly cost significantly less to file than the $800 refund.

Each taxpayer’s circumstance is different.  If you are facing a similar situation and would like advice, contact me at WBerkowitz@BerdonLLP.com or your Berdon advisor.

Wayne Berkowitz, a tax partner and head of the State and Local Tax Group at Berdon LLP, advises on the unique requirements of governments and municipalities across the nation.

[1] For those of you who don’t get the reference, Spaceballs the 1987 science fiction parody of Star Wars, produced, directed, and co-written by Mel Brooks, revolved around the phrase “May the Schwartz be with you.”  While certainly not my favorite from Mr. Brooks, it has been rumored that a sequel entitled, Spaceballs 2: The Search for More Money may be made one day.

[2] See FTB Notice 2017-01, Subject: Court of Appeal Decision in Swart Enterprises, Inc. v. Franchise Tax Board (2/28/17).

[3] See California Tax News, January 1997.

Topics: SALT TALK

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