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The Long Arm of the Franchise Tax Board

Dave was a young man from Washington. He had lived in Seattle his whole life, and never had any plans of leaving. In fact, Dave had just purchased a $1 million home 20 minutes from downtown Seattle.


Dave had cousins in California who were avid real estate investors. They would regularly form LPs (Limited Partnerships) to syndicate deals. They would then use these LPs to buy commercial properties. To finance the purchase, they would raise money from investors and give them an equity stake in the syndicate LP.


After seeing his cousins’ success, Dave asked his cousins if he could invest with them. They agreed, and allowed Dave to invest $100,000 in their next deal. Dave then set up a Wyoming LLC to invest the $100,000 into the syndicate LP, which owned a new $100 million shopping center in Southern California.


The first year was very successful. The center was fully occupied and had lots of foot traffic. The monthly checks investors received from the syndicate LP were much higher than expected.


Dave was happy that he invested in the deal. That was until he received a letter from the California Franchise Tax Board (FTB) demanding that he pay the $800 franchise tax for his passive Wyoming LLC.


How could this be? The syndicate LP paid its $800 fee to California. His Wyoming LLC was just a passive investor in the syndicate LP. Plus, Dave had never lived in California, and he didn’t even directly own any property there! Despite all this, Dave still needed to cough up the $800 for his Wyoming LLC.


This is all thanks to California’s Revenue & Tax Code Section 23101(b)(3). Under this section, any LLC (or other entity) is doing business in California if the value of its real and tangible personal property in California meets the lesser of two requirements.


The first is that the property exceeds $67,000 (which is yearly adjusted for inflation). The second is that the property exceeds 25% of the taxpayer’s total real property and tangible personal property. If a passive Wyoming LLC meets either requirement, it must pay the annual $800 franchise tax since, under California’s definition, it is doing business there.


Under the second requirement, Dave could argue that because he owned a $1 million home in Washington, and only invested $100,000 in California, that well over 25% of his total real property was located outside of the Golden State.


However, this doesn’t matter to the FTB. And this is because he still meets the first requirement, as his interest in the syndication is worth $100,000, catching his Wyoming LLC (which was passive and had no management authority) into the tax. Dave still had to pay that darn $800 franchise tax for “doing business” in California.


If you don’t live in California, but decide to invest there, you need to know about this franchise tax. If you don’t, you could end up like Dave, wondering why he should invest in California in the future.



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