I received a question at US Tax Aid that is applicable to a lot of people, whether they know it or not. In fact, this is a thing that people get wrong. I’m really happy to get this question. Here is what we received at US Tax Aid.
We reside in California. My wife and I plan to form a Wisconsin LLC prior to closing the purchase of a Wisconsin multi-family property. We will hire a Wisconsin property management firm and likely an on-site manager. I suspect that the Wisconsin LLC will be a disregarded entity on our Federal return, with losses flowing to Schedule E. In this situation, will we be obligated to file a California LLC return and pay the $800 minimum state tax? If so, could this be structured to avoid the California tax?
And my answer:
Normally, we consider nexus (connection) with businesses and real estate. That is no exception in your case, although it’s a little different. For asset protection, you will probably want a WI LLC. You could hold it in your own name, but then you lose the protection of an LLC. If you held it in a CA LLC, you wouldn’t have a standing for any legal action. For example, you couldn’t evict a non-paying tenant. The only way you could do that is to also have it authorized in WI. It’s probably easier to just have a WI LLC.
And now we have the CA issue. California has taken the position that if you live in California and have an LLC in any other state, you must be doing some kind of work in California. That’s their position even if you have a property manager. And for that reason, they want you to also pay the $800 annual fee to them, even if you don’t have a CA LLC. You just have a WI LLC.
Plus, if there is gain, you’ll pay tax in WI. You also have to pay tax in CA because the profit will flow through to your personal tax return, which shows you as a California resident. You will receive a tax credit for the WI tax you pay. So you don’t really have double tax on the income, but you do need to file both a WI return and the CA return.
Unfortunately, there really isn’t a strategy to fix this other than moving outside the state of California. No other state is this rough on residents who invest outside the state.