California Superior Court rules LLC "fee" unconstitutional.

• Author: Dickerson, Valerie C.
• Position: Limited liability companies

In two recent decisions--Northwest Energetic Services, LLC (NES) v. Franchise Tax Board (FTB), Case No. CGC-05-437721 (4/13/06), and Ventas Finance I, LLC (Ventas) v. FTB, Case No. CGC-05-440001 (11/7/06)--the San Francisco County Superior Court held that the limited liability company (LLC) "fee" imposed by California Revenue and Taxation Code (CRTC) Section 17942 is unconstitutional. Although California law requires the FTB to continue imposing the fee until a final decision has been rendered by an appellate court, LLCs registered or doing business in California should consider filing protective refund claims, particularly if the statute of limitations for any year is about to close.

California's LLC Fee

In addition to the $800 minimum fee imposed by CRTC Section 17941 on all LLCs, CRTC Section 17942 also imposes a tiered fee on LLCs. The tiered fee is imposed on all LLCs doing business in California or, if they are not doing business there, that are organized or registered to do business there.

The fee is based on the LLC's total income, defined as gross income plus the cost of goods sold. The fee ranges from zero for LLCs with total income of less than $250,000, to $11,790 for LLCs with total income of $5 million or more. Importantly, there is no provision for apportioning total income when determining the fee. Thus, income earned outside of California's borders is not removed from the LLC's tax base; instead, the fee is calculated with reference to the LLC's entire income, wherever earned.

In both NES and Ventas, the taxpayers argued that the lack of an apportionment mechanism rendered the statute unconstitutional under both the Due Process and Commerce Clauses of the U.S. Constitution.

NES

NES was an LLC organized under Washington state law. Although it was registered with the Secretary of State to do business in California, it conducted no business activities there and had no operations, property, inventory or place of business there. Further, it had no employees, agents or independent contractors acting on its behalf in that state.

For the calendar years 1997 and 1999-2001, NES paid the $800 minimum tax imposed on LLCs by CRTC Section 17941; however, it did not pay the Section 17942 fee. The FTB assessed NES for amounts statutorily required under Section 17942. NES paid the assessment, filed a refund claim and, after exhausting its administrative remedies, filed suit in superior court.

After determining that the "fee" constituted a...