No Day Off for Buehler: California Sources Gain from Sale of Intangible to Domicile and Denies Other State Tax Credit

The California Office of Tax Appeals (OTA) held a California resident was not entitled to claim an other state tax credit (OSTC) for taxes paid to Massachusetts because gain from the sale of an LLC membership interest was wholly sourced to the taxpayer’s domicile under California law.

The taxpayer contended the gain from the sale of an LLC interest was sourced to Massachusetts because the LLC interest had acquired a business situs in Massachusetts under the business situs exception provided in California Revenue and Taxation Code Section 17952 (Section 17952).  Alternatively, the taxpayer argued he and the LLC constituted a unitary business such that his own activities, including the sale of his LLC interest, should be combined and apportioned as one business under California’s regulations for partnerships, Regulation 17951-4(d).  The Franchise Tax Board (FTB) contended the sale of the LLC interest was income from an intangible wholly sourced to the taxpayer’s California domicile.  The FTB also argued Regulation 17951-4(d) did not apply because the gain in question was derived by the taxpayer and was not a distributive share of business income earned by the LLC.

The OTA agreed with the FTB and held the entire gain was sourced to the taxpayer’s California domicile under Section 17952 and denied the taxpayer’s OSTC claim.  The OTA confirmed Ames and Neuschotz (cases generally standing for the proposition that the sale of a partnership interest and distributions from stock are sourced to a taxpayer’s domicile) are still good law.  The OTA also held the LLC interest did not acquire a business situs in Massachusetts simply because the taxpayer and the LLC operated in Massachusetts.  Rather, the OTA explained there must be evidence the LLC interest itself was used in connection with the LLC’s business activities in Massachusetts.  Finally, the OTA held the taxpayer was not unitary with the LLC.  Although the taxpayer was a managing member and contributed services to the LLC, the OTA held this was insufficient to establish a unitary relationship.

The OTA’s decision contrasts with prior California decisions in Metropoulos and the Appeal of Smith, where a nonresident’s distributive share of gain from the sale of an intangible was apportioned to California, rather than sourced to the out-of-state investor’s domicile.