Earlier this year the San Francisco Superior Court issued a proposed decision that the California gross receipts fee imposed on limited liability companies (“LLCs”) is unconstitutional. California Revenue and Taxation Code Section 17942 imposes a graduated gross receipts fee on any LLC that does business in California, is organized in California, or registers with the California Secretary of State. The fee is based on gross income from all sources with no mechanism to apportion such income between California and other state sources.

In Northwest Energetic Services, LLC v. California Franchise Tax Board, the taxpayer was a Washington State LLC that was engaged in activities outside California. They conducted no business in California and had no property or employees in California. Their only connection with California was that it registered with the California Secretary of State.

The Court ruled that the gross receipts fee is a tax, and as such, violates both the Commerce Clause and the Due Process Clauses of the United States Constitution because it is not apportioned to fairly represent the extent of California activity.

Technically, the decision has no binding precedent until a Court of Appeals affirms the decision. Even if affirmed, its scope is unclear.

Peter A. Kleinbrodt