New York CPAs often have to address issues regarding California multitiered partnerships on behalf of their clients. This complex area of tax law has been widely discussed in various articles, but many professionals and taxpayers still have unanswered questions. This article provides an overview of the return obligations of multitiered partnerships in California as well as related pitfalls.

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The immense expansion in the use of multitiered partnership structures has created complex requirements, particularly with regard to state and local taxes. In a multitiered investment entity structure, there may be various state filings required at every level that are not obvious due to the increased complexity and diversity of state tax rules. In addition, many states, particularly California, have enacted substantial penalties for the failure to meet an unnoticed filing obligation.

California Filing Requirement

Pass-through entities such as partnerships, multiple-member limited liability companies classified as partnerships for tax purposes (LLC), and S corporations that are “doing business” in California have a California return filing requirement. For taxable years beginning on or after January 1, 2011, California Revenue & Taxation Code (RTC) section 23101 states that a taxpayer is “doing business” if it has actively engaged in any transaction for the purpose of financial or pecuniary gain or profit in California, or if either of the following conditions are satisfied:

  • The taxpayer is organized or commercially domiciled in California, or
  • The taxpayer’s California sales, property, or payroll exceed the amounts or percentages applicable under paragraphs (2), (3), or (4) respectively, of subdivision (b) of section 23101. [Subdivision (d) provides that these amounts include a taxpayer’s pro rata or distributive share from passthrough entities.]

It is important to note that a California filing requirement exists even if the entity has no California-sourced income. In addition, an entity with at least one LLC member or partner that is a resident or domiciled in California and conducts business in California on behalf of the LLC or partnership must file a California tax return, even if the entity has no Californiasourced income. This added nuance is one of the most common reasons pass-through entities unknowingly do not comply with California filing requirements.

California Penalties

The failure-to-file penalties in California can be quite substantial for a flow-through entity. Pursuant to RTC section 19172, the penalty is $18 per partner per month or fraction thereof that the failure continues, with a maximum of 12 months. In addition, the LLC can be assessed penalties with respect to the California $800 minimum LLC fee and on the California-sourced gross receipts tax, which ranges from $0 to $11,790. These penalties are 5% of the unpaid tax per month or fraction thereof until filed, not to exceed 25% of the unpaid tax. Furthermore, a foreign LLC doing business in California that does not register to do business in the state may be subject to a penalty of $2,000 pursuant to RTC section 19135 if it fails to file the required return within 60 days after the Franchise Tax Board (FTB) sends a notice and demand. Unlike the IRS, the FTB does not offer an abatement of penalties for first-time filers. The FTB has a strict stance on abating penalties. Unless there is reasonable cause, abatement of penalties will not be granted.


Consider a Nevada LP with 100 partners that acquires a minority membership interest in a Delaware LLC that owns and operates several California shopping centers. The Nevada LP may be treated as “doing business” in California by reason of its ownership of a membership interest in an LLC doing business in California, resulting in a California tax filing obligation. If a California return is not filed, the Nevada LP will face an $800 minimum tax for every year it is deemed to be doing business in California. In addition, the Nevada LP could face penalties of $21,600 (the $18 per-partner per-month penalty) plus $2,000 (the penalty for a nonregistered LLC doing business in California) and interest on the tax due for every year it was doing business in California and owes tax.


LLC A is neither organized nor registered to do business in California. It has been conducting business in Nevada since January 1, 2012, has never filed a California LLC return, and has 10 members consisting of individuals, trusts, LLCs, and corporations. Some of the members are California residents, California resident trusts, California domiciled LLCs, and California domiciled corporations. The members of the LLC generally have the right to participate in the management of business, and some of the management decisions are made by members in California. By that activity alone, the members making management decisions in California would constitute “doing business” in California, thereby creating a filing requirement for LLC A. It would have an $800 minimum tax for every year it was doing business in California and a return was not filed. In addition, it could face penalties of $2,160 plus $2,000 and interest on the tax due for every year a California return was not timely filed.

Possible Remedies

California offers a Voluntary Disclosure Program (VDP) that allows qualified entities, shareholders, or beneficiaries that may have an unpaid California tax liability or an unfulfilled filing requirement to disclose their liability voluntarily. The qualified entities, shareholders, or beneficiaries that choose to participate in the VDP are required to pay their California tax liability only for the immediately preceding six taxable years. Business entities that have received a notice from the FTB prior to coming forward will not qualify for the VDP. Under the VDP, the FTB will waive penalties associated with the return filings. The FTB will also waive its authority to assess taxes, additions to taxes, fees, or penalties for the taxable years ending prior to the six taxable years covered by the voluntary disclosure agreement.

The VDP does not apply, however, to pass-through entities other than LLCs and S corporations. The Taxpayers’ Rights Advocate Office (TRAO) has been lobbying for the VDP to apply to other pass-through entities, but that will take legislative action. Paraphrasing the TRAO, the penalties at stake under RTC 19172 are a disincentive to these entities to come clean once they have learned they have a filing obligation in California.

If an entity does not qualify for the VDP, California also offers the opportunity to voluntarily enter into a Filing Compliance Agreement (FCA). Qualified business entities, partnerships, and trusts eligible to enter into a FCA must voluntarily disclose, file, and make full payment to the FTB for all of the years that they failed to file a California tax return. If the entity shows reasonable cause, the FTB is permitted to waive penalties. According to various judicial and administrative rulings, however, simply not knowing there was a return filing obligation is not an acceptable reasonable cause. In addition, business entities, partnerships, and trusts that have already received a notice from the FTB will not qualify for the FCA.

Beware the Pitfalls

California is aggressively pursuing pass-through entities with its broad definition of “doing business.” Taxpayers in a passthrough entity structure, especially a multitiered entity structure, need to be aware of the pitfalls in California, in addition to other states in which the taxpayer may be doing business without being aware of such activities.

Eddie Delgado is a principal, at CohnReznick LLP, New York, N.Y.
Krista Schipp, CPA is a senior tax manager, at CohnReznick LLP, New York, N.Y.
Corey Rosenthal, JD is a principal, at CohnReznick LLP, New York, N.Y.