Morgan Miller Blair

In addition to paying a $800/year minimum franchise tax, LLCs organized or doing business in California and not classified as corporations for tax purposes are required to pay a fee based on gross income (the “gross income fee,” or “GIF”). The GIF ranges from $0 to $11,790 per year depending upon the level of the LLC’s gross receipts. California businesses that are structured as LLCs ought to be aware of two recent noteworthy developments relating to the GIF:

1. As part of its response to the state budget crisis, California has changed the laws governing the timing of payment of the GIF. Previously, the GIF was paid at the time the LLC filed its annual income tax return on FTB Form 568 (by April 15 of the following year for calendar year LLCs). For taxable years beginning after January 1, 2009, the GIF will be due on the 15th day of the 6th month of the current tax year (i.e., by June 15 of the current tax year for calendar year LLCs). This new rule will potentially require some LLCs to pay the GIF twice in 2009! The 2008 GIF was due by April 15, 2009, and the 2009 estimated GIF is due by June 15, 2009.

The amount of the GIF depends upon the amount of gross income for the entire tax year. On June 15 of any given tax year, the LLC will not know what its gross income for the year will be. Thus, the new law requires that the GIF be paid based upon an estimate of gross income for the current year. If the LLC’s estimate is incorrect and it underpays its GIF, it will be subject to a 10% penalty unless the estimated fee is equal to or greater than the GIF for the prior tax year. LLCs are advised to estimate the GIF carefully in order to avoid this penalty.

2. As originally enacted, California’s GIF law applied to worldwide gross income, i.e., not just California source income. An unapportioned tax—a state tax on income sourced outside that state’s borders—clearly would have violated the U.S. Constitution.  However, California took the position that the GIF was a fee, not a tax, and therefore not subject to constitutional restrictions on state taxes. LLCs brought several court challenges to the GIF . In the Northwest Energetic case, the LLC in question had no California source income. The court in that case ruled against California, holding that the GIF was unconstitutional as applied to an LLC with no California source income. In the Ventas Finance case, the LLC contesting the GIF had both California and non-California source income. The court in that case held that the GIF was valid only as applied to California source income.

As these test cases progressed, the California Legislature realized that defeat was imminent, and responded by amending the GIF statute to provide for apportionment, effective for tax years beginning on or after January 1, 2007.

LLCs with non-California source income that have not previously submitted claims for refund of GIF paid for tax years prior to 2007 should consult their CPAs to determine whether to submit a refund claim. See FTB Notice 2008-2 for refund claims under Northwest and FTB Notice 2009-04 regarding refund claims under Ventas.

A related question is whether LLCs that pay the GIF may claim a deduction for California income tax purposes. Because it was considered a “fee”, California historically took the position that the GIF was deductible. However, California does not allow a deduction for tax payments, and hence the FTB may now take the position that a deduction is no longer allowed as a result of the Northwest and Ventas cases and the changes in the GIF statute.