A limited liability company (“LLC”) doing business in California (whether organized under California law or the law of another state) must pay an LLC annual fee on its “total income from all sources derived from or attributable to this state.” (The annual LLC fee is really a tax, but the legislature didn’t want to call it a tax, so it’s an LLC fee. But it still quacks like a tax.)
The LLC annual fee is in addition to the $800 flat annual franchise tax. The LLC annual fee is graduated, starting at $900 for LLCs with total income of $250,000 and topping out at $11,900 for LLCs with total income of $5 million or more.
The Franchise Tax Board (FTB) recently ruled on how to calculate the “total income” in the case of an LLC taxable as a partnership that sells real property. FTB Legal Ruling 2016-01 (July 14, 2016).
If the LLC holds the real property for sale to customers in the ordinary course of business (i.e., it’s a “dealer” in real property for income tax purposes), then according to the FTB, the total income for the purpose of calculating the LLC annual fee includes the adjusted basis of the real property (not just the gain realized).
If the LLC holds the real property for investment (and not for sale to customers in the ordinary course of business), then the total income for the purpose of calculating the LLC annual fee is the gain realized (and the adjusted basis of the real property is not included in the calculation).
The reason for the difference is that “total income” for purposes of calculating the LLC fee is defined in Revenue & Taxation Code § 17942(b)(1)(A) as “gross income, as defined in Section 24271, plus the cost of goods sold that are paid or incurred in connection with the trade or business of the taxpayer.” If the LLC is a dealer in real property, then it’s in a “trade or business,” and the adjusted basis of the real property is part of cost of goods sold. If the LLC holds the real property for investment, the income from the sale of the real property is not from a “trade or business,” and the concept of “cost of goods sold” does not apply.
Here’s a link to the FTB ruling: