Doing Business in California? You May be Even if You do not Think You are

December 9, 2014

For many of our clients, determining whether they do business in California is simple, because they either hold substantial real estate here or engage in the majority of their business dealings here. But whether or not your business is doing business in California is not that simple of a question. So we are going to take this opportunity to address some issues that could come up for those out-of-state businesses doing business in California.

At least, that is the position of California's Franchise Tax Board. As an example, consider a company called Swart Enterprises that runs a farm in Kansas. The company has no physical presence in California, and it owns no property in California. It is a Kansas farm company. However, the Franchise Tax Board claimed that Swart was doing business in California simply because it passively held an investment in a manager-managed California LLC. And the board went on to tax Swart accordingly. Swart filed suit, and the trial court ultimately agreed with the Kansas company, but it remains to be seen what might happen on appeal.

For franchise tax board purposes, "doing business" is defined by 18 CCR Section 23101. According to the Franchise Tax Board, you are doing business in California if your business actively engages in any transaction for the purpose of financial or pecuniary gain or profit in California or if any of these conditions are met:

• The taxpayer is organized or commercially domiciled in California.
• Sales, as defined in subdivision (e) or (f) of R&TC 25120, of the taxpayer in California, including sales by the taxpayer's agents and independent contractors, exceed the lesser of $500,000 or 25 percent of the taxpayer's total sales. For purposes of R&TC Section 23101, sales in this state shall be determined using the rules for assigning sales under R&TC 25135, R&TC 25136(b) and the regulations thereunder, as modified by regulations under Section 25137.
• Real and tangible personal property of the taxpayer in California exceed the lesser of $50,000 or 25 percent of the taxpayer's total real and tangible personal property.
• The amount paid in California by the taxpayer for compensation, as defined in subdivision (c) of R&TC 25120, exceeds the lesser of $50,000 or 25 percent of the total compensation paid by the taxpayer.

For the conditions above, the sales, property, and payroll of the taxpayer include the taxpayer's pro rata or distributive share of pass-through entities. "Pass-through entities" means a partnership, an LLC treated as a partnership, or an "S" corporation.

Before you transact intrastate business in California your business must first be qualified or registered with the California Secretary of State. For purposes of this requirement, "transacting intrastate business" means "entering into repeated and successive transactions of [your] business in this state, other than interstate or foreign commerce. Corporations, LLCs, LLPs, and LPs each have particular paperwork they have to fill out if they are required to register. The Secretary of State's office will not advise you as to whether you are required to register, so this determination would be something to discuss with an experienced California business attorney.