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California ‘doing business’ standard applied to LLC

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On July 7, 2020, the California Office of Tax Appeals (OTA) held that an out-of-state limited liability company (LLC) member whose only connection to California was holding a non-managing membership interest in an LLC was “doing business” in California because its percentage of ownership of LLC property located in the state exceeded the statutory bright-line nexus threshold.1 Therefore, the out-of-state LLC member was subject to the $800 LLC tax even though it only held a non-managing membership interest in the LLC.

Background The appellant in this matter, Aroya Investment I, LLC (Aroya), acquired a minority non-managing membership interest in 1155 Island Avenue, LLC (Island) in December 2014. Island owned a substantial parcel of property in San Diego.2 During the 2016 tax year, Aroya’s ownership interest in Island was approximately 0.78%, and based on the value of Island’s property, Aroya’s pro rata share of the property was approximately $481,000. Aroya timely filed a California LLC return for the 2016 tax year on which it paid the $800 LLC tax, but subsequently filed an amended return requesting a refund on the basis that it was not “doing business” in California. The FTB denied the refund claim and Aroya filed a timely appeal with the OTA.

OTA’s analysis regarding California’s ‘Doing Business’ standard Under California law, every LLC “doing business” in the state is subject to the $800 LLC tax.3 Cal. Rev. & Tax. Code Sec. 23101(a) defines “doing business” as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.” Cal. Rev. & Tax. Code Sec. 23101(b)(2)-(4) further provides that in tax years beginning on or after January 1, 2011, a taxpayer is deemed to be doing business in California if it satisfies one of three bright-line factor-presence nexus thresholds consisting of sales, property, or payroll amounts. For the 2016 tax year, the bright-line property threshold was $54,771.4

In its refund claim, Aroya did not dispute the fact that its distributive share of California property may have exceeded bright-line nexus standards under Cal. Rev. & Tax. Code Sec. 23101(b)(3), and instead argued that it was not “doing business” in California based on the California Court of Appeal’s 2017 decision in Swart Enterprises, Inc. v. Franchise Tax Board.5 In Swart, the Court of Appeal applied the “doing business” standard of Cal. Rev. & Tax. Code Sec. 23101(a), as applicable in tax years beginning before January 1, 2011, to an out-of-state LLC passively owning a 0.2% minority interest in an LLC that was doing business in California. Under these facts, the Court of Appeal held that the taxpayer in Swart was not “doing business” in California solely by virtue of owning a fractional minority interest in an LLC that was doing business in California.6

The OTA disagreed with Aroya’s interpretation of Swart in several respects. First, the OTA noted that beginning in 2011, “subdivisions (a) and (b) of R&TC section 23101 contain two alternative tests for doing business, and the satisfaction of either test leads to a nexus finding.”7 The OTA explained that under this framework, meeting the nexus standard under either subdivision (a) or (b) of Cal. Rev. & Tax. Code Sec. 23101 is sufficient to be “doing business,” and once it is determined that a taxpayer is “doing business” in California, it “ends the inquiry.” The OTA clarified that Swart only applies to taxable years beginning before January 1, 2011, prior to subdivision Cal. Rev. & Tax. Code Sec. 23101(b) being added to the code. Thus, due to Aroya’s distributive share of Island’s California property exceeding $54,771 in 2016, the OTA concluded Aroya was “doing business” in California and subject to the $800 LLC tax.

Commentary This unanimous decision by the OTA provides additional clarity on how to apply California’s “doing business” standards in taxable years beginning on or after January 1, 2011. As described by the OTA, if taxpayers meet one of the statutory bright-line “doing business” thresholds in Cal. Rev. & Tax. Code Sec. 23101(b), the inquiry concludes, and they are considered to be doing business in California. If it is determined that none of the bright-line thresholds in subdivision (b) is met, the analysis must proceed to determine whether the doing business standard of subdivision (a) is met (as analyzed in Swart). In short, just because a taxpayer has not met one of the bright-line nexus tests does not mean the inquiry should end, because the “doing business” definition in Cal. Rev. & Tax. Code Sec. 23101(a) could still potentially be satisfied. Furthermore, taxpayers should always pay close attention to their distributive share of payroll, property, and sales passing through from partnership, LLC, or S corporation ownership interests, because Cal. Rev. & Tax. Code Sec. 23101(d) directs that the bright-line nexus thresholds include a taxpayer’s pro rata or distributive share of payroll, property, and sales from such ownership interests.



1 Appeal of Aroya Investment I, LLC, California Office of Tax Appeals, No. 19074982 (July 7, 2020) (pending precedential status).
2 Island acquired the property from the Thomas Jefferson School of Law.
3 CAL. REV. & TAX CODE § 17941(a).
4 The threshold amount is adjusted annually for inflation, and when enacted was originally $50,000.
5 7 Cal App. 5th 497 (2017).
6 For a discussion of Swart, see GT SALT Alert: California Court of Appeal Holds Small Non-Managerial Interest in LLC Does Not Constitute Doing Business in State.
7 Emphasis in original.



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