Tax Insights

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AZ sues CA over “doing business” interpretation

Franchise Tax BoardIn the latest battle over the position of the Franchise Tax Board on taxpayers doing business in California, the State of Arizona has decided to sue California. Arizona is alleging that California is imposing an unconstitutional tax against Arizona businesses and individuals who don’t conduct any business in California.

California currently imposes the California $800 annual minimum tax on out-of-state entities if they are a member of another LLC or corporation which does business in California. Arizona argues that holding a mere passive ownership interest in another entity does not rise to the level of “doing business.”

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After filing in February, Attorney General Mark Brnovich announced that five national organizations and law professors have joined in the fight against California’s $800 minimum tax assessment. Arizona estimates that Arizona citizens pay over $10 million in “unconstitutional” taxes to the State of California every year. In addition, since the taxes paid to California are tax deductible, Arizona loses out on tax revenue each year.

In 2018, the FTB issued Legal Ruling 2018-01 which allows an out-of-state member to own 0.2% of an entity and not be subject to California’s $800 minimum tax under some circumstances (following the facts of the Swart case) but doesn’t give further guidance if ownership is above this tiny minimum.

Arizona is also protesting California’s collection procedures. The Arizona attorney general stated:

California frequently further tramples on the sovereignty of other states by issuing orders to interstate banks, demanding that they transfer funds in Arizona-based accounts for back payment. Those seizure orders threaten the banks that, if they do not transfer the funds, California will take the taxes and penalties owed from the banks instead.

This case was filed directly with the United States Supreme Court since it’s the only court that hears cases in which one state sues another. You can find more information on the Arizona AG’s website here and here.

KC Kolb, CPA