Arizona Suing California over California’s “Doing Business” Rules

Understanding “Doing Business” Rules in California

The Attorney General for Arizona is suing the State of California regarding the constitutionality of California’s law subjecting a taxpayer to California’s minimum franchise tax of $800 (the “minimum tax”). The case was brought before the Supreme Court of the United States because it has original jurisdiction in matters in which a state sues another state.

Under the “doing business” law, a taxpayer has nexus with California if the taxpayer is a member of a limited liability company (LLC) which is doing business in California, even though the member may not be registered with the California Secretary of State and authorized to do business in the state. Therefore, each member of the LLC would be subject to the minimum tax. 

Recent Limited Liability Company Cases

There have been two recent cases in California where a taxpayer has challenged the “doing business” law. In these cases, the LLC was operated day to day by managers (“manager-managed LLC”), not by the members. The court in both cases found that the LLCs’ members were passive investors and were not doing business in California; therefore, they were not subject to the minimum tax. [See Swart Enterprises, Inc. v. California Franchise Tax Board and In the Matter of the Appeal of Satview Broadband, LTD.] The court treated these members as limited partners of a limited partnership.

For a limited partnership doing business in California, a limited partner — if it has no other activity or physical presence in California and is not registered with the California Secretary of State — is considered not to be doing business under California law and is not subject to the minimum tax. The reasoning is that the limited partner is a passive investor and does not control or operate the partnership. In contrast, the general partner of a limited partnership is doing business under California law and is subject to the minimum tax.

Why Is Arizona Suing California?

Arizona is suing California regarding the constitutionality of this law as it affects LLC members. The Attorney General of Arizona contends that a passive investor of a limited liability company is not doing business in California and should not be subject to the minimum tax. He argues that the minimum tax is unconstitutional under the Due Process and Commerce Clauses of the U.S. Constitution. We will have to wait and see what the U.S. Supreme Court decides.

How Does This Affect My Business?

In the meantime, taxpayers that are passive investors, not managers, in limited liability companies and are not registered with the California Secretary of State should consider filing protective claims requesting a refund of the minimum tax; such refunds will be held in abeyance until the decision is made by the U.S. Supreme Court. 

Overwhelmed? Need Help?

Weaver’s State and Local Tax Services professionals can help you navigate the impact of California’s doing business rules. If you would like more information about how it may apply to your business, contact us or see the latest state tax news at weaver.com.

Authored by George W. Rendziperis, J.D., and Aaron Humphreys, CPA

© 2019