The evolution of the California filing requirements for foreign partnerships.

• Author: Armstrong, Marc
• Position: Califorrnia Taxing

California has been aggressively expanding its income tax filing base to include foreign (i.e. out of state) partnerships that otherwise have limited connection to California. Many foreign partnerships and LLCs are unintentionally failing to file a California tax return when their only connection to the state is through a passive investment interest in a lower-tier, pass-through entity.

This mistake is compounded for an LLC because of the recent introduction of a S2,000-a-year penalty for tax years beginning on or after Jan. 1, 2013, for foreign LLCs that are considered to be "doing business" in California and fail to register to do business in California, or whose business has been suspended or forfeited. In addition, other applicable penalties can quickly add up for large partnerships:

* $18-per-partner-per-month penalty (up to a maximum of 12 months) for failure to file;

* 5 percent late filing penalty per month (up to a maximum of 25 percent of the unpaid tax and fee, if applicable);

* 5 percent failure-to-pay-penalty that increases by 0.5 percent a month (up to a maximum penalty of 25 percent for every month unpaid); and

* 10 percent underpayment of estimated fee penalty (if applicable).

As a general rule, a partnership has a California filing obligation if it is considered to be "doing business" in California. Doing business has been statutorily defined as "... actively engaging in any transaction for the purpose of financial or pecuniary gain or profit."

For tax years beginning on or after Jan. 1, 2011, this definition has been expanded to include being organized or commercially domiciled in California, or having the partnership's apportionment factors (property, payroll or sales) exceed a certain threshold adjusted annually for inflation (i.e. the bright-line economic nexus standards).

Moreover, foreign partnerships are triggering California filing obligations because of the mandatory, single-sales-factor-apportionment formula for sales of other than tangible personal property. In addition--in determining its property, payroll or sales in California--a partnership must include its distributive share of any apportionment factors from any lower-tier, pass-through entities.

Furthermore, a foreign LLC may be considered to be doing business in California by virtue of its resident members conducting business in California on its behalf [Appeal of Mockingbird Partners LLC (May 17, 2006) Cal. St. Bd. of Equal, Case No. 306061],

California...