Court Rules that Taxpayer’s Ownership Interest in a Manager-Managed California LLC Isn’t Considered “Doing Business”

In Swart Enterprises Inc. v. Franchise Tax Board, the California Court of Appeal rejected the California Franchise Tax Board’s (FTB) broad definition of “doing business” in the state and its attempt to impose the $800 minimum tax on an out-of-state business. The statute defines doing business as “actively engaging in any transaction for the purpose of financial or pecuniary gain or profit.”

Swart Enterprises was a small family-owned business incorporated in Iowa. It didn’t have any real or personal property nor employees in California; it didn’t sell or market products or services in the state; and wasn’t registered with the California Secretary of State. In 2007, its only connection to the state was a 0.2 percent ownership interest in a manager-managed California LLC.

The FTB argued that Swart’s ownership interest in the LLC, which elected to be treated as a partnership for federal tax purposes, required Swart to file a California corporate franchise tax return and pay the $800 minimum tax. In rejecting the FTB’s position, the court noted that Swart was a passive investor in the LLC. It had no authority to participate in the management and control of the LLC; and it wasn’t liable for the debts and obligations of the LLC.

Under these circumstances, Swart’s interest was akin to that of a limited partner and couldn’t be considered “doing business” even if the LLC was “doing business” in California.

We're Here to Help

We expect the FTB to file a petition for review with the California Supreme Court to challenge this decision. If you’d like to better understand how to proceed in the meantime or how an eventual decision may affect your business, contact your Moss Adams professional or the below State & Local Tax director:

John Clausen
E-mail | (408) 558-5775