When a Texas parent's LLC (taxed federally as a partnership) sells all its assets, is the gain included in the parent corporation's Texas franchise-tax receipts?

Plain-English summary

An auditor asked whether a corporation's franchise-tax receipts should include a gain that its LLC realized. The facts: the taxpayer (a corporation) owns an LLC that elected to be taxed as a partnership federally; on August 25, 2000 the LLC sold all of its telecommunications assets to a buyer, and the taxpayer did not sell any of its LLC interest. The Comptroller said the gain is not in the taxpayer's receipts.

• The misread precedent. The requestor relied on letter 9709756L, but that letter involved a sale of a 90% interest in an LLC - a sale of an investment, whose gain is included in the seller's receipts and tax base (and apportioned as a sale of an intangible). That is a different transaction from this one.
• Here there is no sale of an interest. The LLC sold its own assets; the taxpayer still holds all of its investment in the LLC. So the 9709756L analysis does not apply.
• The agency disregards the federal partnership election. For franchise tax, the agency imposes tax on each corporation doing business in Texas and disregards the LLC's federal partnership election. Disregarding the election, the LLC (not the taxpayer) recognizes the gain in the LLC's receipts and federal taxable income. The gain is therefore excluded from the taxpayer's receipts and federal taxable income.
• Nexus and unitary income are beside the point. This result holds whether or not the LLC has Texas nexus, and the facts raise no unitary-income issue.

Currency note: This letter describes the pre-2008 franchise tax, which taxed corporations and generally disregarded an LLC's federal partnership election. The current margin tax (effective January 1, 2008 under House Bills 3 and 3928) treats LLCs and partnerships as taxable entities, so this analysis does not carry forward; confirm current law.

What this means for you

Corporations that own LLCs (pre-2008 franchise tax)

Under the old franchise tax, who actually sold what mattered. When your LLC sold its own assets (and you kept your interest), the gain sat with the LLC - not with you - because the agency looked past the federal partnership election. That differs sharply from selling your interest in the LLC, where the gain would land in your receipts and base.

Auditors and multistate professionals

Distinguish an asset sale by the entity from an interest sale by the owner before sourcing the gain. A letter addressing an interest sale (like 9709756L) does not control an entity-level asset sale, and the federal check-the-box election did not govern the pre-2008 franchise result.

Common questions

Q: Was the LLC's asset-sale gain part of the corporate owner's Texas receipts?
A: No. The agency disregarded the LLC's federal partnership election, so the gain stayed in the LLC's receipts and federal taxable income, not the owner's.

Q: Why didn't letter 9709756L apply?
A: That letter addressed a sale of a 90% interest in an LLC (a sale of an investment); here the LLC sold its own assets and the owner kept its interest.

Q: Did the LLC's Texas nexus (or lack of it) change the answer?
A: No. The Comptroller said the rationale holds whether or not the LLC has nexus, and no unitary-income issue arose.

Citations and references

Related letter:

• 9709756L - addressed a sale of a 90% LLC interest (a sale of an investment), distinguished here because this taxpayer sold no interest

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200203907L

Original ruling text

March 27, 2002

SUBJECT: Assets sales by LLC & federal election

Taxpayer owns a limited liability company (LLC). LLC has elected to be treated
as a partnership for federal income tax purposes. On August 25, 2000, LLC sold
all of its assets used in connection with its telecommunications business to
COMPANY. Taxpayer did not sell any of its interest in the LLC and still holds
all of its investment in the LLC today.

LLC has no nexus with Texas; thus, LLC's gain on the sale of its assets is not
subject to franchise tax in Texas. The gain on the sale of the LLC's assets
was subject to tax in Nebraska.

My research suggests "the sale of the interest in the LLC is the sale of
partnership interest, and not as a sale of the underlying asset." See
9709756L. Thus, I believe this transaction should be included in everywhere
receipts and federal taxable income. Taxpayer claims that this is a sale of
LLC's assets and that the gain should not be included in Taxpayer's receipts
and federal taxable income.

QUESTIONS:

1. Should the gain from the sale of assets of LLC be included in the everywhere
   receipts of Taxpayer?

2. Does the fact that LLC has NO nexus in Texas a consideration for
   classifying the revenue as non-unitary income and should be excluded from
   Taxpayer's receipts and federal taxable income?

Answer: You have misread the applicability of 9709756L ("taxability letter")
to your facts. In the taxability letter, Company A transferred assets to a LLC
that Company A owned. Company A then sold 90% of its interest in LLC to
Company B. LLC elected to report tax as a partnership for federal income tax
purposes. The part of the taxability letter addressed the gain recognized by
Company A from the sale of its 90% interest in LLC. The portion of the
taxability letter that you rely on merely restates the federal tax treatment of
the sale of the 90% interest. It is not a statement of the agency's policy.
For franchise tax purposes, the sale of the 90% interest is a sale of an
investment, and the gain recognized from that sale would be included in Company
A's receipts and tax base. This is the basis for the taxability letter
agreeing with the requestor that the gain should be apportioned as a sale of
intangible assets and qualifying that the gain would be included in the earned
surplus tax base if the gain were unitary income.

The taxability letter, however, has no relevance to your audit because the
Taxpayer in your audit has different facts. There is no sale of an interest in
an entity. (You acknowledge this point when you state that Taxpayer still
holds all of its investment in LLC today). Taxpayer owns LLC, and it is LLC
that sold some of its assets to COMPANY. LLC recognizes a gain from the sale
of its assets, which affects its federal taxable income. However, because LLC
is being treated as a partnership for income tax purposes, the gain was
distributed to Taxpayer and is reflected in Taxpayer's federal taxable income.
The agency's policy requires the imposition of franchise tax on each
corporation doing business in Texas. We have to disregard LLC's election for
federal income tax purposes. If we do that, LLC would recognize the gain in
LLC's receipts and the gain would be part of LLC's federal taxable income,
which means we would exclude the gain from Taxpayer's receipts and federal
taxable income. This rationale is true whether LLC has nexus or no nexus;
thus, the answer to your first question is "no." Your facts do not raise any
unitary income issue.

ASK POLI - 200203907L