Watch out for California's late-filing penalty for LLCS investing in LLCS.

• Author: Baptise, Philip
• Position: Limited liability companies

Recently, many LLCs owning an interest in an LLC that conducts business in California have been receiving billing notices with high penalties for failing to timely file California Form 568, Limited Liability Company Return of Income. Commonly, California identifies an LLC member of an LLC conducting business in California and sends a notice requesting the filing of Form 568 if the entity has not already done so.

Many LLCs that are not connected to California other than via investment interests in LLCs that are conducting business in California are unknowingly not complying with California's filing requirements, especially if the California apportioned net income is small or a loss. Once the return is filed, California sends a billing notice that includes a penalty that may be substantially higher than the original amount due with the return. How can this be? An analysis of this issue requires a review of California's treatment of LLCs.

California's Revenue and Taxation Code Section 17942 subjects California LLCs to an $800 annual tax plus an annual fee based on the amount of apportioned California gross receipts. The annual fee ranges from $0 for apportioned gross receipts below $250,000 to a high of $11,790 on apportioned gross receipts of $5 million or more. Apportioned gross receipts of a lower-tier LLC are disregarded in calculating the fee on an upper-tier LLC. The tax and annual fee are reported on California Form 568, which is due on the 15th day of the fourth month after the LLC's year end. Failure to make the annual filing subjects the LLC to a penalty of $18 per member per month up to a maximum of 12 months. In addition, the LLC is subject to a late-filing penalty of 5% per month (or part thereof) up to a maximum of 25% of the unpaid LLC tax and fee (if applicable) and a failure-to-pay penalty that begins at 5% and increases by 0.5% for each month the payment is late, up to a maximum penalty of 25%.

Furthermore, an LLC doing business in California that does not register to do business in California or whose right to do business in California has been suspended or revoked is now subject to a penalty of $2,000. The "failure to register" penalty is effective for tax years beginning on or after Jan. 1,2013. This penalty can be assessed by the Franchise Tax Board annually (California Franchise Tax Board, Form 568 Booklet, 2013, p. 3).

Example: LLC A, which has 100 members, invests in private-equity deals. In 2011, LLC A purchases a I%...