Not surprisingly, the Franchise Tax Board has ruled that out of state based corporate owners of ?disregarded entities? (one a wholly owned subsidiary of an S corporation treated as a QSub corporation, and the other, a wholly owned LLC) were subject to California income/franchise taxation based solely upon the business activities of their subsidiaries. Legal Ruling 2011-01 http://ftb.ca.gov/law/rulings/active/lr11_01.pdf.
The Ruling noted that an S corporation can form a wholly owned subsidiary and make a QSub election. The subsidiary, as a QSub, is treated for federal and California income/franchise tax purposes as if it does not exist. Its income and expenses are deemed earned/ incurred by the parent corporation. Furthermore, under California income/franchise tax law the activities of the QSub are treated as activities of the parent corporation:
?Therefore, ? if a QSub has activities sufficient to constitute ?doing business? in the State, the QSub owner is ?doing business? in California and therefore must pay a franchise tax or the minimum tax, whichever is greater.?
A corporation (among other entities) can form a wholly owned limited liability company or LLC and unless the parent corporation elects the LLC to be taxed as a corporation, it is treated under federal and California income/franchise tax law as a disregarded entity; that is, like the QSub, the LLC can be treated for federal and California income/franchise tax purposes as if it does not exist:
?For an ? (LLC) ? treated as a disregarded entity for income/franchise tax purposes, the legal result is that the ? (LLC?s) ? activities, which are sufficient to establish that ? the (LLC) ? is ?doing business? in California, are treated as the activities of its owner, and the owner is thereby ?doing business? in California.?
The result is that the owners of the QSub and wholly owned LLC are subject to California income/franchise tax:
?As a result of ?doing business? in California,? (these out of state parent corporations) ? have substantial nexus with California ?; and ? are therefore required to file a California franchise tax return ? (and) ? pay the associated tax ??
Comment. Being a disregarded entity is optional. An S corporation can form a subsidiary corporation and it will not be a disregarded entity unless the parent corporation makes a timely QSub election. A corporate owner of a wholly owned LLC can avoid disregarded entity treatment by making a timely election to have the LLC taxed as a corporation.
By John McCauley: Mr. McCauley is a lawyer based in southern California who provides legal counsel to companies.
Email:???????? jmccauley@mk-law.com
Profile:?????? http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone:? 714 273-6291
Source: http://www.multistatebztax.com/?p=470
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