February 27, 2008
FOR IMMEDIATE RELEASE
California Court of Appeals Affirms Annual LLC Fee an Unconstitutional Tax.
In a recent decision, the California Court of Appeals (the "Court") affirmed a trial court decision that
California’s annual levy on limited liability companies (LLCs) imposed under Revenue and
Taxation Code, Section 17942 was in fact a tax and, as imposed on an LLC based outside the state,
violated the Commerce Clause of the U.S. Constitution. With respect to the issue of attorney’s fees,
the Court reversed and remanded the lower court’s decision on an upward adjustment to the lodestar.
In the instant case, the LLC was organized under the laws of the State of Washington and had no
operations, property, employees, or sales in California. However, the LLC had registered with the
California Secretary of State and paid the minimum tax imposed under Section 17941. It did not
pay any amounts under Section 17942 based upon its “total income from all sources reportable to
this state for the taxable year.”
In a de novo review, the Court first addressed whether or not the levy imposed under Section
17942 constituted a tax or a fee. Based upon the legislative history, the Court concluded that
the levy “more closely resembles a tax.” The state advanced several arguments that the levy
was in fact a fee and not a tax. However, the Court determined it to be a tax, based on the
fact that it was a mandatory payment imposed for raising general public revenues, rather than
a payment made at the LLC’s option to compensate the government for services or benefits
provided to them. In reaching this decision, the Court stated that
“[t]he legislative history
of the LLC Act demonstrates unequivocally that the Levy’s purpose was to raise revenue in
order to make up for the loss of income tax proceeds that would result if entities were
formed and operated as LLCs instead of corporations.”
Once the Court determined that the levy was a tax, rather than a fee, it then addressed the
issue of whether or not the levy was unconstitutional. The state advanced several arguments
that the imposition of the levy was constitutional and even presented an argument that
Northwest Energetic Services, LLC (“Northwest”) should be barred from raising a Commerce Clause challenge to the levy.
Ultimately, the Court held that “[i]n sum, whether the Levy is called a tax or a fee,
and whether we apply the internal consistency test, the external consistency test, or
the Pike balancing test, the application of the Levy to Northwest in the Years in Issue
violated the Commerce Clause.”
The statute has since been amended for the levy to be measured only on income derived from
sources within California (Northwest Energetic Services, LLC v. California Franchise Tax
Board (Cal. Ct. App. 2008) January 31, 2008).
TECHNICAL INFORMATION CONTACTS:
<< Back to Tax Developments