On November 20, 2019, the California Franchise Tax Board (FTB) issued Legal Ruling 2019-02, in which it concluded that a limited partnership (LP) disregarded for federal income tax purpose (a federal DLP) is not required to pay California's annual $800 minimum tax on LPs, nor is it required to file a California partnership return. Simultaneously, the FTB issued Notice 2019-06, setting forth the process for a taxpayer to substantiate that it is a federal DLP and describing how to file refund claims.

Affected LPs should review the ruling and notice and take the appropriate steps to submit refund claims based on Legal Ruling 2019-02.

Background

In general, most legal entities that are deemed to be "doing business" under California's tax statute must file an annual return and pay an $800 minimum franchise tax. This includes certain entities, such as limited liability companies (LLCs), that are disregarded for California franchise or income tax purposes.

California Revenue and Taxation Code (CRTC) Section 17935 specifically requires an annual tax on LPs doing business in California. Before Legal Ruling 2019-02, the FTB maintained that disregarded LPs were subject to the $800 minimum tax and had a filing obligation. Taxpayers challenged FTB's assessments, asserting that the FTB lacked authority to require a filing and annual tax payment because CRTC Section 23038 states: "If the separate existence of an eligible business entity is disregarded for federal tax purposes, the separate existence of that business entity shall be disregarded."

Legal Ruling 2019-02

The FTB, in reversing its prior position, concluded in Legal Ruling 2019-02 that federal DLPs are not required to pay California's annual tax on LPs under CRTC Section 17935 and are not required to file a California partnership return under CRTC Section 18633.

In support of its conclusion, the FTB explained that CRTC Section 23038(b)(2)(B)(iii) generally disregards the separate existence of an eligible business entity for California franchise and income tax purposes if its separate existence is disregarded for federal tax purposes. Although limited exceptions to CRTC Section 23038(b)(2)(B)(iii) apply to LLCs, no exception applies to LPs. Thus, CRTC Section 23038(b)(2)(B)(iii) applies to LPs and "indicates" that there are no annual LP tax or partnership tax return filing requirements for federal DLPs.

Notice 2019-06

Notice 2019-06 sets forth the process for a taxpayer to substantiate that it is a properly disregarded entity for federal income tax purposes, as discussed in the FTB's Legal Ruling 2019-02. Properly disregarded LPs that receive or have received a Filing Enforcement Notice from the FTB can submit the following documentation to establish that they are not subject to the annual LP tax or tax return filing requirements:

  • Certificate of limited partnership, partnership agreement, ownership organizational chart, and partners' federal returns for the tax year(s) in question

or

  • A signed declaration stating that the entity was disregarded for federal income tax purposes during the respective tax years¹

The FTB will review the submitted documentation and determine whether the LP established that it is a federal DLP, as previously discussed.

LPs that have filed refund claims based on an interpretation of CRTC Section 23038(b)(2)(B)(iii) that is similar to Legal Ruling 2019-02's must submit the documentation for (1) or (2) to the FTB (to the fax number or address in Notice 2019-06). New refund claims based on Legal Ruling 2019-02 must be submitted by the LP's local law general partner in the same manner.

Refund claims can be filed for open tax years. California has a four-year statute of limitations unless the statute is being held open longer by a California or federal waiver.

Implications

There are currently appeals before the California Office of Tax Appeals (OTA) on the issue of whether federal DLPs have a filing obligation and requirement to pay the $800 minimum tax. The FTB's change in position on this matter will help resolve a number of these appeals. Affected taxpayers, including those with tiered disregarded partnership structures, such as real estate or management companies, should review Notice 2019-06 and timely submit the appropriate documentation to the FTB.

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ENDNOTE

¹ The declaration must be signed under penalty of perjury by the LP's general partner under local law. If the general partner is an LLC, the manager (or, if no manager, the LLC's authorized member) must sign the declaration.