California Refund Opportunity for Disregarded Entities

The California Franchise Tax Board (FTB) recently issued a legal ruling (LR) that concludes that limited partnerships treated as disregarded for federal income tax purposes are not required to file income tax returns or pay the $800 annual tax. The LR was issued on November 20. In addition, the FTB issued Notice 2019-06 providing the process for establishing that a federal limited partnership is disregarded for federal income tax purposes and describing how to file refund claims.

BACKGROUND

Previously, the FTB held that pursuant to the California Revenue and Taxation Code (CRTC), a limited partnership is required to pay an annual tax for doing business in the state of California and to file an income tax return. As a general rule, most entities that are deemed to be “doing business” under California’s law are required to file an annual return and pay the annual tax, including limited liability companies (LLCs) that are disregarded for federal income tax purposes.

Taxpayers challenged the FTB’s assessments, asserting that it lacked authority to require a filing and annual tax payment, since the CRTC states that if the separate existence of an eligible business entity is disregarded for federal tax purposes, its separate existence is generally disregarded for California franchise and income tax purposes other than for purposes of expressly specified limited exceptions. The exceptions do not apply to a federal disregarded limited partnership (DLP).

As a result, the FTB reversed its prior treatment of DLPs for federal income tax purposes and concluded that DLPs are not required to pay California’s annual tax nor file a California partnership return.

GUIDANCE

According to the LR, limited partnerships (LPs) that are properly disregarded pursuant to FTB guidelines and have received a Filing Enforcement Notice from the FTB should submit the following documents:

1. Certificate of limited partnership, partnership agreement, organizational chart of ownership, and federal returns of the partners for the particular taxable year or years in question; or
2. A signed declaration under penalty of perjury that the entity was disregarded for federal income tax purposes during the respective tax years.

Upon review, the FTB will determine whether the LP established that it is a federal DLP and is not required to file an income tax return or pay the annual tax.

MARCUM RECOMMENDATION

Refund claims may be filed for open tax years. Since the California Statute of Limitation is only four years, you are advised to review your refund potential with your Marcum tax advisor and timely submit the appropriate documentation to the FTB.