Series LLCs and the Great State of California

I’m a huge fan of Series LLCs in many instances. I think they offer entrepreneurs and real estate investors a quality solution at a good price. But there are some caveats to that statement. And anytime someone starts off with “I live in California …” a warning alarm goes off inside my head.

That’s because California has some very aggressive tax nexus laws when it comes to out-of-state business structures owned by business residents. Those laws were tough before, but in 2011 became even stricter, when California adopted a new set of guidelines over when you do and don’t have to register a structure into the state.

Nexus means connection, and in the case of taxes, the trick is getting something from outside the state to connect to inside the state. If you live in Cali, unfortunately that something is often you. The state looks at it this way: if there is work being done in the state on behalf of that out-of-state company, especially if it’s being done by one of the owners, then the company has enough of a connection to the state to trigger a tax burden.

OK – that’s not really an unusual stance. There are lots of states that want you to declare income from everywhere on your return. It’s not out of line to ask someone in California to declare the income they’ve received from a real estate investment based in Missouri, and held in a Missouri LLC, for example. Remember, if you’ve paid taxes on that income in Missouri, you’ll get an offset for what you owe in California. It’s not a question of making you pay twice.

But here’s where the state gets tricky. Starting in 2011, if you lift a finger to help that Missouri LLC in any way, and you do it from your home in Fresno, *boom* – you now have created enough of a connection, in the state’s eyes, to compel you to register that Missouri LLC into California as a foreign entity. And THAT now puts you in line for the California privilege tax of $800 (or more) per year on your structure. And, because the tax is defined as a privilege tax, it’s payable no matter what. You may have a lousy year and lose a million dollars –but California still will want to get their $800 minimum.

There’s plenty of opposition to this new position, and some legal challenges slowly working their way through the system. So this may not always be the case. Remember, California used to try and apply state tax to worldwide income, until that got smacked down a few years ago. But it’s what we have to work with right now.

Where a Series LLC is concerned though, things go from bad to worse – or from expensive to “are you kidding me?” That’s because the Franchise Tax Board has published its position on Series LLCs and has stated that if any of the Cells has business in California, the whole structure is considered to have nexus. Not only are you asked to do a cross-registration to bring in the Parent LLC, you’re also asked to voluntarily list and register each Cell with the Franchise Tax Board and pay the minimum $800/year privilege tax on each Cell. So if you’ve got 5 properties in Missouri, but you live in Fresno, you’ve just been handed at least $4800 in extra taxes to use a Series LLC (Parent + 5 Cells @ $800ea = $4,800). These are privilege taxes, so it comes off your top line, and you’ve still got personal tax to worry about down the road.

It’s hard for me to recommend someone use a Series LLC if they live in California, except in some very limited circumstances. I don’t think setting you up for a massive tax hit is in your best interests. If you are in Cali, make sure you talk to your advisor and see if there are any ways you can structure your business entities to reduce this tax, ideally before you’ve got a structure set up and running.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

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