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CALIFORNIA, HERE WE COME (WITH OUR REFUND CLAIMS)

March 09, 2006

A California judge has ruled the state's "franchise fee" on limited liability companies unconstitutional. It's about time. (Hat Tip: TaxProf Blog).

BACKGROUND

California imposes a stiff fee on LLCs doing business there. The fee is based on the worldwide gross income of the LLC, regardless of how little of it comes from California. The fee schedule is as follows:

- $ 900, if total income is $250,000 or more, but less than $500,000;

- $2,500, if total income is $500,000 or more, but less than $1 million;

- $6,000, if total income is $1 million or more, but less than $5 million;

- $11,790, if total income is $5 million or more.

As this isn't an income tax, taxpayers only have to cross the very low "commerce clause" nexus threshold to get hit. An LLC with gross income of $5 million isn't very big, but if it so much as sniffs the scented air of the Golden State, it owes $11,790.

NO APPORTIONMENT, NO TAX

Northwest Energetic Services LLC, an explosives distributor, did almost no business in California. It sued for a refund of the franchise fee. The California Superior Court held for the taxpayer because:

- The fee had no connection to the costs of regulating California LLCs, so it was a tax, and
- As an unapportioned tax it violated the Commerce Clause of the U.S. Constitution.

WHAT TO DO?

It would be premature to stop paying the fees, as the state is sure to appeal. Taxpayers with fees due April 17 should plan to pay them.

While the appeals work themselves out, taxpayers who have paid the LLC fee should prepare to file refund claims; the claims for calendar year 2001 are due April 15. California has a four-year deadline for refund claims on timely-filed returns.

UPDATE: California practitioner Russ Fox has more.

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