“Doing Business” in California

“What do you mean I have to pay California tax on my LLC? It’s registered in (name a state)”

How many times have I heard a California client say that in an outraged tone?

Many people register their LLCs in other states, in an effort to avoid California taxes. There was a time when TV ads commonly promoted Nevada LLCs to California residents, and even I had an out-of-state LLC a long time ago, before I knew better – but I was advised by a reputable law firm who also should have known better.

Why is it an Issue?

A feature of operating a California LLC or corporation is the $800 minimum tax. There is also an additional fee for LLCs, depending on gross income attributable to California.

So, it makes sense to register your LLC in another state, and avoid the tax, right? … Wrong.

California Filing Requirements

An LLC is required to file a California tax return, Form 568, and pay the required taxes if:

• The LLC is formed in California
• The LLC is registered with the California Secretary of State

OR…

•  The LLC was not formed in California, but “does business” in California.

So yes, the issue is the definition of “doing business” in California.

Doing Business in California

My clients rarely accept this easily, and argue that they can’t be doing business in California if the LLC is registered in another state. Here’s the California law on the subject:

California Publication 3556 states that an LLC is doing business in California “if any of the LLC’s members, managers, or other agents performs activities in California on behalf of the LLC, regardless of where the LLC otherwise conducts business.”      

Here’s an example from the same publication. It is a common situation in my experience:

Example:  Paul is a California resident and a member of a Nevada LLC. The Nevada LLC owns property in Nevada. The LLC hires a Nevada management company to collect rents and provide maintenance. Paul has the right to hire and fire the management company. He occasionally has telephone discussions from California with the management company in Nevada regarding the property. He is ultimately responsible for the property and oversees the management company. Paul conducts business in California on behalf of the LLC. The LLC must file Form 568.

Will They Catch Me?

Once they are persuaded that the filing requirement applies to them, my clients often ask what would happen if they don’t file in California, but only in the state where the LLC is registered.

Maybe they won’t catch you. BUT… your tax return is in the system. It shows you are a California resident, and that you had a K-1, or filed a return for an LLC in another state. The information is easily available to anyone who chooses to search for it.

And California is aggressive. They do file demands for tax returns, and assess tax, penalties and interest on unpaid balances. They do go to court, and they do win.

Conclusion

Not surprisingly, I advise that you file a California tax return for your LLC, even if it is registered in another state.

But consider…

•  If you transfer the LLC to California, you may avoid fees and end reporting requirements in the original state.

OR…

• If you are the sole member of the LLC, maybe it isn’t doing you any good, and you may be better off terminating it.