Does membership in an LLC taxed as a partnership generally make the member itself 'doing business' in California after the Swart decision?

Plain-English summary

Legal Ruling 2018-01 modifies two passages of California Legal Ruling 2014-01 after the Court of Appeal's Swart decision. The FTB concluded that the older ruling needed clearer language about the relevance of manager-managed versus member-managed LLCs and about a possible exception for a very small, passive member.

The modified general rule is:

• If an LLC is classified as a partnership for tax purposes and is doing business in California under section 23101, its members are generally considered to be doing business in California under partnership-law principles.
• Those members generally have California return-filing obligations and are subject to applicable California taxes and fees.
• A narrow exception may apply in limited circumstances, as recognized in Swart Enterprises, Inc. v. Franchise Tax Board and FTB Notice 2017-01.

The ruling also modifies an example involving “Member J.” Member J owned 15% of the LLC. The FTB emphasized that this stake greatly exceeded the passive 0.2% membership interest involved in Swart, so the example continued to apply the general doing-business attribution rule.

The 2018 ruling does not withdraw Legal Ruling 2014-01; it expressly modifies it with the replacement language quoted in the source.

What this means for you

Out-of-state members of California-active LLCs

Do not assume that having no separate California office or employees ends the analysis. If the LLC is taxed as a partnership and does business in California, the FTB's general position is that the LLC's doing-business status is attributed to its members.

Small passive investors

The ruling recognizes a narrow Swart-type exception but does not define it as a simple percentage threshold. The comparison it does make is clear: the modified example's 15% interest was far larger than Swart's 0.2% passive interest. Management rights, control, activities, and the full ownership facts remain important.

Accountants and tax professionals

Read Legal Ruling 2014-01 together with this modification and later authority. The 2018 ruling replaces specific language in the earlier document; relying on the original passages without the modification would overstate the rule and omit the narrow exception.

Common questions

Q: Does every member of a California-active partnership-taxed LLC automatically do business in California?
A: The FTB says members are generally treated that way, but the ruling recognizes that a narrow exception may apply in limited circumstances.

Q: Is the exception based only on ownership percentage?
A: No fixed threshold is stated. The ruling notes that 15% greatly exceeds the 0.2% interest in Swart, but it does not say percentage alone controls.

Q: Does manager-managed status by itself prevent attribution?
A: No. The ruling was issued to clarify that the manager-managed/member-managed distinction does not replace the general partnership-law analysis.

Q: What obligations can follow from attribution?
A: The ruling says members generally have California return-filing requirements and are subject to applicable taxes and fees.

Q: Did this ruling revoke Legal Ruling 2014-01?
A: No. It modifies specified passages of Legal Ruling 2014-01.

Citations and references

• Cal. Rev. & Tax. Code § 23101 (doing business)
• Swart Enterprises, Inc. v. Franchise Tax Board (2017) 7 Cal.App.5th 497
• FTB Notice 2017-01 (Court of Appeal decision in Swart)
• California Legal Ruling 2014-01 (modified by this ruling)

Source

• Landing page: California FTB Legal Rulings
• Official PDF: Legal Ruling 2018-01

Original ruling text

STATE OF CALIFORNIA
FRANCHISE TAX BOARD
chair Betty T. Yee| member George Runner| member Keely Bosler

Legal Division MS A260
PO Box 1720
Rancho Cordova, CA 95741-1720

October 19, 2018

LEGAL RULING 2018 - 01

SUBJECT: MODIFICATION OF LEGAL RULING 2014-01: BUSINESS ENTITIES THAT ARE MEMBERS OF MULTIPLE-MEMBER LIMITED LIABILITY COMPANIES CLASSIFIED AS PARTNERSHIPS FOR TAX PURPOSES

PURPOSE

Legal Ruling 2014-01 sets forth the department’s analysis on a number of “doing business” scenarios involving members of multiple-member limited liability companies (LLCs) that are classified as partnerships for tax purposes. After a review of subsequent judicial authority, the Franchise Tax Board has determined that some of the language in that ruling, specifically relating to the relevance of the distinction between “manager-managed” LLCs and “member-managed” LLCs, should be revised to provide additional clarity and guidance.

DESCRIPTION OF SPECIFIC MODIFICATIONS

The first paragraph on page four of Legal Ruling 2014-01 is modified to read:

If an LLC is treated as a partnership for tax purposes, both the LLC and its members, are subject to the same legal principles applicable to any partnership. Thus, if an LLC classified as a partnership for tax purposes is "doing business" in California under Section 23101, the members of the LLC are themselves generally considered to be "doing business" in California. A narrow exception may apply in limited circumstances. (See Swart Enterprises, Inc. v. Franchise Tax Board (Cal. App. 5th Dist. 2017) 7 Cal. App. 5th 497; see also FTB Notice 2017-01, Subject: Court of Appeal Decision in Swart Enterprises, Inc. v. Franchise Tax Board, February 28, 2017.)

The third paragraph on page 10 of Legal Ruling 2014-01 is modified to read: Yes. Because LLC I is classified as a partnership for tax purposes and is "doing business" in California within the meaning of Section 23101, all of LLC I's members are generally considered to be "doing business" in California, and thus have California return filing requirements and are subject to all applicable taxes and fees, because LLC I's attribute of "doing business" is attributed to its members under general principles of partnership law. A narrow exception may apply in limited circumstances. (See Swart Enterprises, Inc. v. Franchise Tax Board (Cal. App. 5th Dist. 2017) 7 Cal. App. 5th 497 ("Swart"); see also FTB Notice 2017-01, Subject: Court of Appeal Decision in Swart Enterprises, Inc. v. Franchise Tax Board, February 28, 2017.) Please note that Member J’s 15 percent membership interest in

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Legal Ruling 2018 – 01
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LLC I greatly exceeds the taxpayer’s 0.2 percent membership interest in the Swart Court of Appeal decision.

EFFECT ON OTHER RULINGS

Legal Ruling 2014-01 is modified as described herein.

DRAFTING INFORMATION

The principal author of this Legal Ruling is Adam J. Susz of the Franchise Tax Board, Legal Division. For further information regarding this ruling, contact Mr. Susz at the Franchise Tax Board, Legal Division, P.O. Box 1720, Rancho Cordova, California 95741-1720.