Out-of-State Partnership in California
The company LCP VII Holdings LP was a foreign partnership with holdings in entities both in the United States and abroad. The company had California-source income from pass-through entities. On the basis that they did not do business in California, they did not file tax returns in the state.
When LCP VII Holdings LP was asked for their tax return by the Franchise Tax Board (FTB), they did not respond in the required time, leading the FTB to issue a notice of proposed assessment of tax, penalties, and interest. So LCP filed their tax returns for the four years from 2011-2014. The partnership ended up paying a mere fee of $800 in annual taxes with an additional fee for filing after the deadline. Then, they filed for a refund for the penalties, but the FTB denied their request, leading them to appeal to the Office of Tax Appeals. 2019 OTA 399 (Nov. 19, 2019).
In its appeal, the partnership claimed that it did not operate any business in California and was not registered to do business in the state, it was just a limited partner in pass-through entities. And so, its failure to file on time was due to their understanding that it was not doing business in California according to the definition put forth in Revenue & Taxation Code section 23101 and under the California Court of Appeals decision in Swart Enterprises, Inc. v. Franchise Tax Bd. (2017) 7 Cal.App.5th 497. While the partnership was not “doing business” in California within the meaning of Swart, the case was based upon the test for “doing business” in Revenue & Taxation Code section 23101(a). The Revenue & Taxation Code contains an alternative test in section 23101(b) (sometimes called the economic nexus test), which Swart did not address.
Under Revenue & Taxation Code section 23101(b)(2), if a taxpayer has sales that occurred in California exceeding $500,000 or 25% of their total sales, it is considered to be “doing business” in California.
The partnership in question was found to exceed this $500,000 limit and so the penalties for late filing were upheld.
If the taxpayer has property in California exceeding $50,000 or 25% of their total property, they are doing business in California.
If the taxpayer pays compensation exceeding $50,000 or 25% of their total paid compensation, they are doing business in California.
Each of the figures above were set in 2011 and are adjusted annually for inflation. The 2019 figures are $601,967 for the sales test, $60,197 for the property test, and $60,197 for the compensation test.