When do California's bright-line nexus thresholds make a passive investor a taxpayer?

The two tests, and what the case law decided

The subdivision (a) case law rewards precision about what it held. Swart Enterprises, Inc. v. Franchise Tax Board (2017) 7 Cal.App.5th 497 held that an Iowa corporation's 0.2 percent interest in a manager-managed California LLC was not active engagement; the decision involved a taxable year before 2011, and the court noted in a footnote that the then-new bright-line tests did not apply to that year. The Office of Tax Appeals extended the principle in Appeal of Jali, LLC (2019, precedential), holding non-managing interests between roughly 1 and 5 percent insufficient and, importantly, rejecting the Franchise Tax Board's invitation to read Swart as a 0.2 percent ceiling: there is no percentage bright line under subdivision (a); the inquiry is management participation and the power to participate. The same body drew the other boundary in Appeal of Wright Capital Holdings LLC (2019, precedential), where a 50 percent member was doing business, because an interest of that size carries significant authority over the entity's activities and the taxpayer failed to prove it lacked the power to participate in management. Wright Capital's quiet lesson is evidentiary: the burden of showing passivity sits on the investor, and an operating agreement that strips the member of management rights is the exhibit that carries it. A general partner interest is decided differently: in Appeal of GEF Operating, Inc. (2020-OTA-057P, precedential), the sole general partner of two California limited partnerships was itself doing business under subdivision (a), and the Office of Tax Appeals rejected the argument that subdivision (b) provides a safe harbor for an entity whose numbers fall below the thresholds. The Franchise Tax Board, for its part, has long read the whole line narrowly, treating Swart as an exception to its position that members of partnership-classified LLCs doing business in California are themselves doing business (Legal Ruling 2014-01; Franchise Tax Board Notice 2017-01; Legal Ruling 2018-01), but that position is now subject to correction under a court-approved settlement. On September 10, 2026, the San Francisco Superior Court gave final approval to a class settlement in Bahl Media, LLC v. California Franchise Tax Board (No. CGC-16-554150), covering refund claims of entities whose only California connection was a passive interest, defined for that action as an interest of 50 percent or less, in an LLC doing business in California. Under the settlement, the Franchise Tax Board agreed to correct and clarify Legal Ruling 2014-01, Notice 2017-01, and Legal Ruling 2018-01 consistent with Swart and the Office of Tax Appeals' precedential opinions, including that an entity is not doing business solely because it holds more than a 0.2 percent interest in such an LLC. The settlement resolves only claims under section 23101(a) and the minimum tax and does not touch the subdivision (b) thresholds, and as of October 9, 2026 the Franchise Tax Board had posted no corrected guidance; the court's compliance hearing is set for March 12, 2027. Until the clarification issues, positions in the middle ground, meaningful minority stakes and ambiguous management rights, should be papered with litigation in view.

None of that matters to subdivision (b). In Appeal of Aroya Investment I, LLC (2020-OTA-255P, precedential), a Delaware LLC held a 0.7830849 percent non-managing interest in an LLC that owned California real property with an original cost around 61.5 million dollars. Under subdivision (d), Aroya's share of that property, roughly 481,000 dollars, was Aroya's own California property for threshold purposes, and it exceeded that year's property threshold many times over. The opinion is direct about the architecture: subdivision (d) makes no distinction between active and passive ownership or between general and limited interests, the 2011 legislation was designed to reach owners of pass-throughs with economic presence in California, and once a bright-line threshold is exceeded, no analysis under subdivision (a) is necessary at all. Later opinions applied the same mechanics to interests in the 2 to 5 percent range (Appeal of LA Hotel Investments #3, LLC, 2021-OTA-218P) and to a tiered 5.21 percent interest (Appeal of MJK Real Estate Fund II, LLC, 2022-OTA-247P). The pattern to internalize: Jali and Wright Capital were decided under subdivision (a) because the thresholds were either not asserted or not met; Aroya is what happens when they are. Subdivision (b) is also broader than its numbers. It reaches any taxpayer organized in California or commercially domiciled there, meaning the principal place from which its trade or business is directed or managed sits in the state, without regard to its sales, property, or payroll (Rev. and Tax. Code sections 23101(b)(1), 25120(b)). For a blocker or holding company run from California, that prong decides the question before any threshold is computed.

The arithmetic, and why small percentages fail it

The thresholds are indexed annually; for taxable year 2025, the latest year for which the Franchise Tax Board has published figures, they stand at 757,070 dollars of California sales, 75,707 dollars of California real and tangible personal property, and 75,707 dollars of California payroll, each measured as the lesser of the dollar amount or 25 percent of the taxpayer's total everywhere. Two features make them hazardous for investors. First, the property and payroll thresholds are small absolute numbers, and a distributive share is a percentage of whatever sits underneath. A fund or venture holding a 100 million dollar California asset walks every member with more than roughly 0.076 percent of it over the property line; a fund with 10 million dollars of California property does the same for any member above roughly 0.76 percent. Owned property counts at original cost and rented property at eight times its net annual rent, each averaged between the beginning and end of the taxable year (Rev. and Tax. Code sections 23101(b)(3), 25130, 25131), so appreciation is not the driver, and in an acquisition year the averaging can halve the base, but leverage is irrelevant: the gross asset, not the equity, is what the percentage multiplies. Second, the lesser-of construction means the 25 percent alternative can only lower the bar, never raise it; for a diversified investor the dollar figures govern, and they are cleared by exposure, not by concentration. Sales work the same way for investors in operating pass-throughs: the member's share of the entity's California-sourced receipts counts toward the sales threshold, which means a passive stake in a business with meaningful California revenue can produce factor nexus with no California asset at all. For taxable years beginning on or after January 1, 2026, the sales side of that computation runs through the amended market-based sourcing regulation (Cal. Code Regs., tit. 18, section 25136-2, as amended effective for taxable years beginning on or after January 1, 2026), so a 2026 computation should not assume the prior years' sourcing answers carry over. The reliable way to know where an investor stands is the tiered computation the statute implies: for each pass-through in the chain, the investor's share of California sales, property at cost, and payroll, aggregated across all holdings, compared against the year's thresholds, every year, because the thresholds move and so do the portfolios. The share in that computation is measured by the investor's interest in profits, not its capital or loss interest, and it is traced through every tier (Cal. Code Regs., tit. 18, section 25137-1(f)(4)). The Office of Tax Appeals settled the point precedentially in Appeal of MJK Real Estate Fund II, LLC (2022-OTA-247P): a member's 2013 and 2014 share of California property, computed through its 5.21 percent interest in an LLC holding a 6.99 percent profit interest in the property-owning tier, came to 47,343 dollars, below that year's threshold, and the member was not doing business; once the property sat in disregarded entities owned outright by the upper-tier LLC, the same member's share was 677,300 dollars and it was. The profit interest in MJK was 6.99 percent while the capital and loss interests were 52.35 percent, and the choice between them decided the outcome; that divergence is routine in fund waterfalls, which makes the measurement rule as consequential as the thresholds themselves.

Nexus is not measure, and the floor is not the ceiling

Clearing a threshold makes the investor subject to the franchise tax and its minimum; it does not decide how much California can tax, and missing every threshold does not make California irrelevant. A corporate investor that is not doing business is still subject to the corporation income tax on its California-source income, though not to the franchise tax or its minimum (Rev. and Tax. Code section 23501(a); Cal. Code Regs., tit. 18, section 23101(b)), and individual investors are taxed on California-source income without regard to the doing-business test at all (section 17951(a)); the thresholds decide franchise-tax status, not whether California is owed anything. For an investor that is itself an LLC, the immediate consequence of doing business is the annual tax and a filing obligation, plus the LLC fee once its total income from California sources reaches 250,000 dollars (Rev. and Tax. Code sections 17941, 17942); for a corporate partner, it is the franchise tax with its minimum and the return. Secretary of State qualification is a separate test: holding a limited partnership interest or an LLC membership is not by itself transacting intrastate business (Corp. Code section 191(b)), so crossing a threshold does not by itself create qualification exposure. What the bright lines do not do is convert the investor's income into California income. The measure question still runs through the analysis in the companion article on corporate partners in investment funds: unitary or not, business or nonbusiness at the partnership level, apportionment on the partnership's factors or allocation under the nonbusiness rules, including the commercial-domicile allocation of nonbusiness intangible income. A non-California-domiciled corporate investor can therefore clear a 23101(b) threshold, owe the minimum franchise tax and a return, and still properly report little or no California-source income, and the inverse is just as real: a California-domiciled blocker may owe California tax on all of its interest income that is nonbusiness income at the partnership level under the allocation rules, whether or not any threshold was ever computed. Keeping the two questions separate is not pedantry; it is what prevents a nexus concession from being mistaken for an income concession, and vice versa, in audit correspondence.

Practice notes

The compliance discipline for fund investors is an annual threshold computation run with the K-1s: every pass-through interest's share of California sales, property at original cost, and payroll, aggregated, against that year's indexed amounts, documented even in the years it comes out negative, because the computation is the defense. Structuring choices should be priced with the flow-up rule in mind: dividing an investment among affiliates does not help if each affiliate's share still clears the small property threshold, and blocker placement decides which entity's name ends up on the California return. Where subdivision (a) is the Franchise Tax Board's theory, the operating agreement is the case: the papers should withhold management rights from the passive investor, and the investor should be able to prove a negative, no votes cast on operations, no committee seats, no consent rights over ordinary business, because Wright Capital puts that burden on the taxpayer. Where subdivision (b) is the theory, the choices are to contest the numbers, including how the profit interest traces through the tiers under MJK, or to concede the status and contest the measure; audit capital spent arguing Swart against a threshold computation is wasted, because the precedential answer is already written. And for the entity that discovers factor nexus late, the exposure is often the annual or minimum tax, penalties, and filing history rather than a large income number, which makes it a candidate for the cleanup tools, voluntary disclosure among them, before the Franchise Tax Board's data matching finds the K-1 first, since the same K-1 that reports the distributive share to the investor reports the investor to the Franchise Tax Board. G&G State Tax Group provides nexus analysis and voluntary disclosure representation for passive investors alongside its state and local tax practice.