Will California tax a Delaware-based LLC?

August 26, 2008

From:  Reiling
Date:  18 Sep 2007

We are thinking about forming an LLC to buy and manage real estate. One of the partners lives in Delaware and the rest in the San Francisco Bay Area. We are considering forming the LLC in Delaware. (1) Will California tax our business income? (2) If the LLC is set up in Delaware, will the individual members have to pay tax in both states or the state with the higher income tax?

Answer

Date:  26 Sep 2007

Hello Reiling,

You have stumbled into a hornet’s nest.

First, when a member lives in a state that imposes an income tax, the state of residence generally imposes the income tax on the worldwide income of the resident. There may be an offsetting state tax credit if another state imposes tax on the same income.

If real estate is located in a state that imposes an income tax, any income relating to the property is generally taxable in that state.

The California Franchise Tax Board has been very aggressive in finding that an LLC that has members who are California residents are subject to tax in California, requiring them to pay an $800 tax plus a fee based on "worldwide" gross receipts. These positions are in litigation right now.

Before you go ahead, consult with an attorney and a qualified tax advisor who is familiar with these issues.

Good luck!
Mike Gray

We have more answers to frequently asked real estate tax questions! We also offer up-to-date information about new tax real estate tax developments in Michael Gray, CPA's Real Estate Tax Letter.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained on this website was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.