Tiny Interest + Big Property = California Nexus: Office of Tax Appeals Determines Minority LLC Interest Creates Taxable Nexus

On July 7, 2020, the California Office of Tax Appeals (OTA) held that a foreign LLC was subject to the state’s $800 LLC tax because it held a 0.7830849% ownership interest in an LLC that owned property in San Diego. In addition to a more traditional nexus test based on an entity’s business activities in the state, California has a bright-line nexus test tied to threshold sales, property, and payroll amounts. In particular, a corporate entity is doing business in California if its real and tangible personal property in California exceeds the lesser of $50,000 – adjusted for inflation – or 25% of its total real and tangible personal property. In making this determination, California takes into account the entity’s pro rata share of California property owned by pass-through entities in which it held an interest. The OTA concluded that because the foreign LLC’s pro rata share of the California LLC’s property – valued at over $60 million – exceeded this threshold, the foreign LLC had nexus for purposes of the $800 LLC tax.

The OTA rejected the taxpayer’s comparison to Swart Enterprises, Inc. v. Franchise Tax Board (2017) 7 Cal.App.5th 497, in which the California Court of Appeal held that an out-of-state corporation was not doing business in California despite its passive holding of a 0.2% ownership interest in a manager-managed LLC that did business in the state. The OTA concluded that Swart was inapplicable because that case was decided under California’s historical “doing business” test, and not the bright-line factor presence test. The OTA also determined that the bright-line tests do not distinguish between active versus passive ownership interests, or general versus limited partnerships.

In the Matter of the Appeal of Aroya Inv. I, LLC, 2020-OTA-255P (Cal. Office of Tax Appeals Jul. 7, 2020) (pending precedential).