Important Disclaimer

May 2006

California's Annual Fee For LLC Ruled Unconstitutional
Prepared By: Melissa C. Marsh

California levies two separate and different annual taxes on limited liability companies (LLCs): (1) an annual $800 minimum tax on LLCs formed in California and foreign LLCs qualified to do business in California; and (2) if the LLC is classified as a partnership, a second annual fee on the LLC's total gross income, as follows:

In Northwest Energetic Services LLC v. California Franchise Tax Board, Case No. CGC-05-437721 (Cal. Sup. Ct. (S.F. Cty.) March 3, 2006, a California Superior Court issued a proposed statement of decision that California’s second annual fee on LLCs "Total Gross Income From All Sources" is unconstitutional. The court reasoned that the annual Total Gross Income Fee is a "tax," and as such violates both the Due Process and Commerce Clauses of the U.S. Constitution because it does not provide an exception for income earned in other states in which the LLC does business. The California Attorney General filed objections to the court's statement of decision and no final decision has been rendered. If the court rules in favor of Northwest Energetic Services LLC, the California Franchise Tax Board will likely appeal.

Until there is a final ruling, LLCs should continue to pay the Annual Total Gross Income Fee for current and future tax years to avoid suspension or the assessment of interest and penalties. However, LLCs that have previously paid the annual fee on Total Gross Income for open years (calendar year 2002 and thereafter) should consult with their tax return preparers to file a Protective Refund Claim for the years 2002 to present. To file this claim, the LLC should send a letter to the Franchise Tax Board via confirmed fax (916-845-9796) or registered mail (FTB, P.O. Box 942867, Sacramento, CA 94267-8888). The letter should contain the LLC's name, identification number, and the name, telephone number and fax number of a contact person. The letter should also include a statement that the LLC is filing a protective claim for the tax years involved (specifically state which years), the amount of the claim (specifically state the amount of the annual fee on Total Gross Income paid by the LLC for each tax year involved), and the reason for the claim (because the LLC fee on Total Gross Income is unconstitutional). The letter should be signed by a managing member.

Upon receipt of the protective claim, the FTB will send a fax confirmation of receipt. The FTB will defer action on all claims pending a final appellate decision on the issue of the LLC fee’s constitutionality. Taxpayers should retain a copy of their original protective claims, as well as the FTB’s confirmation receipt, in their files.

LLCs subject to the annual fee on Total Gross Income should continue to pay the tax until there is a final appeallate court ruling.

© Melissa C. Marsh 2006 All Rights Reserved.

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Disclaimer: This article has been prepared by Melissa C. Marsh for general informational purposes only and does not constitute legal advice. Readers should not rely or act upon the information contained in this article for any purpose without seeking legal advice from a local licensed attorney in your state. This article is not, and should not be used as, a substitute for legal advice as your specific factual circumstances may differ, the laws of your jurisdiction may differ, and the laws may have changed. Your use of this Internet site does not create an attorney-client relationship. Transmission of this article is not intended to create, and receipt of it does not constitute, an attorney-client relationship. All uses of the contents of this site, other than personal uses, are prohibited.