December 2, 2001

A limited liability company (“LLC”) is the most popular entity used to own commercial real estate because it gives its owner both pass-through tax treatment and liability protection. A disadvantage to utilizing an LLC organized under California law or qualified to do business in California is the annual fee described below imposed by California on LLCs. Recent legislation has modified the annual fee to eliminate double counting of LLC income in the case of multi-tiered LLCs.

THE EXISTING FEE STRUCTURE
Revenue and Taxation Code (“R&TC”) Section 17941 imposes an annual minimum tax of 0 on every LLC doing business in California and on any LLC organized in California or qualified in California even if that LLC is not doing business in California. In addition to the minimum tax, R&TC Section 17942(a) imposes an annual fee on every LLC subject to tax under Section 17941. This annual fee was imposed by California for the purpose of recouping tax revenues that would otherwise be lost through the use of LLCs in California, and the fee schedule is adjusted each year to reflect such revenue impact. An LLC’s annual fee is determined by its "total income" (gross income plus cost of goods sold) of the LLC from all sources, not just from California sources. The annual fee increases incrementally as the LLC’s total income reaches certain thresholds (see the table below) up to a maximum (for 2001) of ,814 for LLC’s having ,000,000 or more of total income. There is no annual fee (just the 0 minimum tax) if the LLC’s total income is less than 0,000.

The LLC annual fee schedule for 2001 and prior years is as follows:

LLC’s Total Income 1996-98 Fee 1999 Fee 2000 Fee 2001 Fee
Less than 0,000 $ 0 $ 0 $ 0 $ 0
0,000 or more, but less than 0,000 500 865 1,042 979
0,000 or more, but less than ,000,000 1,500 2,595 3,126 2,938
,000,000 or more, but less than ,000,000 3,000 5,190 6,251 5,876
,000,000 or more 4,500 7,785 9,377 8,814
NOTE: The annual fee for any year can be obtained at the Franchise Tax Board’s web site at www.ftb.ca.gov/legal/notices by referencing the applicable FTB Notice.

CHANGE IN FEE STRUCTURE
Recent California legislation has addressed the “double counting” problem that previously existed in computing LLC fees. Under the prior law, each LLC in an ownership chain would be required to include in its total income, for purposes of determining the annual fee, its allocable share of total income from each LLC in which it held an ownership interest, even if that income had previously been taken into account in determining the annual fee of such other LLC. For example, assume that LLC1, LLC2 and LLC3 were each subject to the annual fee, the sole asset of LLC1 was 100% of the membership interests in LLC2 and the sole asset of LLC2 (perhaps a mezzanine borrower) was 100% of the membership interests in LLC3 (the property owner). On these facts, the total income derived from the property would be taken into account once in determining the annual fee of LLC3, a second time in determining the annual fee of LLC2 and a third time in determining the annual fee of LLC1.

The new California legislation, applicable to taxable years beginning on or after January 1, 2001, redefines “total income” in calculating the annual fee to exclude income allocated to an LLC from another LLC that is subject to the California fee. Thus, under the new legislation, the income derived from the property in the above example would be taken into account only once in determining the annual fee of LLC3. This is good news, as tiered LLC structures owning California real estate (or otherwise doing business in California) will no longer be subject to a multiplicity of annual fees.

For more information or to arrange an interview, please contact Leeza Hoyt or Vanessa Amin, The Hoyt Organization, 310-373-0103 or the following attorney at Pircher, Nichols & Meeks: Richard Kaplan 310-201-8938.

Founded in 1983, Pircher, Nichols & Meeks is a national real estate law firm with a diversified real estate practice that includes litigation, bankruptcy, corporate, tax and public finance matters. Based in Los Angeles, the 45-attorney firm also maintains a full-service office in Chicago. The Los Angeles office is located at 1925 Century Park East, Suite 1700, Los Angeles, CA 90067; phone: (310) 201-8900.