California Partnership Tax Guide: Form 565, LLC Fees & CA PTET

The Federal Starting Point: Form 1065 and Schedule K-1

Every California partnership discussion starts at the federal level. Your partnership files Form 1065 with the IRS. That return reports total income, deductions, credits and losses. It doesn’t produce a tax bill — partnerships are pass-through entities, meaning the entity itself doesn’t pay federal income tax. Instead, each partner gets a Schedule K-1 showing their share of partnership items, and those items flow to the partner’s personal return.

This sounds straightforward until you realize that K-1 income is taxable whether or not the partnership actually distributed cash. A partner with a 30% interest in a partnership that earned $500,000 reports $150,000 of income on their personal return — even if every dollar stayed in the business checking account. That’s the fundamental tension of pass-through taxation, and it matters a lot when you layer California rules on top.

The K-1 also drives partner basis calculations. Your outside basis increases when you contribute cash, get allocated income, or pick up additional partnership liabilities. It decreases when you take distributions, get allocated losses, or the partnership pays down debt. If you receive distributions exceeding your basis, the excess is taxable gain. If your losses exceed basis, they’re suspended until you restore it. These mechanics are covered in more detail in our Schedule K-1 and Basis guide.

Form 565: California’s Partnership Return

California requires partnerships to file Form 565 with the Franchise Tax Board. This is the state-level equivalent of Form 1065, but it’s not a carbon copy. Form 565 starts with federal amounts and then applies California-specific modifications — differences in depreciation methods, addbacks for certain deductions California doesn’t allow, and adjustments for California-source versus non-California-source income.

The filing deadline matches the federal deadline: March 15 for calendar-year partnerships, with extensions available. Miss the deadline and California imposes a late-filing penalty of $18 per partner per month, up to 12 months. For a five-partner firm, that’s $1,080 if you’re a full year late. Not catastrophic, but entirely avoidable.

One thing that catches people off guard: California requires Form 565 even if the partnership had zero California-source income, as long as the partnership is organized in California or has a general partner who’s a California resident. The filing obligation isn’t triggered by income alone — it’s triggered by the entity’s connection to the state.

Form 568 and the LLC Fee: California’s Extra Layer

Here’s where California gets expensive. If your entity is a limited liability company taxed as a partnership — which describes most multi-member LLCs — you file Form 568 instead of Form 565. The reporting is similar, but Form 568 comes with two additional costs that general partnerships don’t face.

First, there’s an annual $800 minimum franchise tax. Every LLC owes this regardless of income. You could lose money all year and still owe California $800. It’s due by the 15th day of the 4th month after the LLC’s tax year begins — April 15 for calendar-year LLCs.

Second, there’s the LLC fee, which is based on total income (not net income — total income). The fee schedule as of the most recent guidance:

• Total income $250,000 to $499,999: $900
• Total income $500,000 to $999,999: $2,500
• Total income $1,000,000 to $4,999,999: $6,000
• Total income $5,000,000 and above: $11,790

The fee is based on total income — gross revenue, not profit. An LLC with $1.2 million in revenue and $1.1 million in expenses still owes the $6,000 fee despite making only $100,000 in profit. This is one of the most complained-about features of California’s LLC regime, and it’s a real factor when deciding whether to form your entity in California versus another state. We see clients every year who didn’t account for this when they set up their LLC and are surprised by the bill.

The LLC fee is estimated and paid by the 15th day of the 6th month of the tax year (June 15 for calendar-year entities) using Form 3536. You’re estimating your total income for the year at the six-month mark, which is an awkward exercise for businesses with variable revenue.

California-Source Income: Who Owes What

California taxes nonresident partners on their share of California-source partnership income. That means if your partnership operates in California and has partners in Texas and New York, those out-of-state partners still owe California tax on the income sourced to California.

How does California determine source? For service businesses, the rules focus on where the services are performed. For sales of tangible goods, California uses a market-based sourcing approach — where the customer receives the product matters more than where you shipped it from. For sales of intangibles and services, market-based sourcing applies too: income is sourced to where the benefit of the service is received.

This gets complicated fast. A consulting firm based in San Francisco with clients in 15 states needs to source its income across all those states. A real estate partnership is simpler — rental income from a building in Los Angeles is California-source income, period. But a partnership that trades securities? That income might not be California-source at all, depending on the facts.

California also requires partnerships with nonresident partners to either withhold tax on those partners’. Shares of California-source income or get the partners to consent to California jurisdiction by filing Group Return consent forms. The withholding rate is 7% of the nonresident partner’s share of California-source income. Failing to withhold can make the partnership itself liable for the tax.

The CA PTET: California’s Pass-Through Entity Tax Election

California introduced its pass-through entity tax (PTET) as a workaround for the federal $40,000 cap on state and local tax deductions. The concept is straightforward: instead of partners deducting their state taxes on their individual returns (where the deduction is capped), the partnership itself pays an entity-level tax, and the partners claim a credit on their individual California returns.

The CA PTET rate is 9.3% of qualified net income. The election is made annually — it’s not a one-time decision. The partnership makes the election on an original, timely-filed return. Once elected, all qualified partners are included. You can’t cherry-pick which partners participate.

The mechanics work like this: the partnership pays 9.3% of each qualified partner’s distributive share of income. Each partner then claims a credit on their individual California return equal to their share of the PTET paid. The net effect is that the state tax payment becomes a deduction at the entity level (reducing federal taxable income for all partners) rather than an individual deduction subject to the $40,000 SALT cap.

Estimated payments for the PTET are due on the same schedule as individual estimates: April 15, June 15, September 15, and January 15. The first payment of the electing year must equal the greater of 50% of the prior year’s PTET or 50% of the current year’s PTET. Get the estimates wrong and you’ll face underpayment penalties at the entity level.

One wrinkle that’s easy to miss: the PTET credit is nonrefundable on the individual return. If a partner’s California tax liability is less than their PTET credit, they can carry the excess forward for five years, but they can’t get a refund of the difference. For partners with significant out-of-state income or large deductions that reduce their California tax, the credit might not be fully usable in the current year.

Partner Basis and California-Specific Adjustments

Partner basis tracking is already complicated at the federal level. California adds another dimension because the state doesn’t conform to every federal provision. When California decouples from a federal depreciation method or disallows a specific deduction, partners can end up with different federal and California basis amounts.

The practical impact: a partner might have sufficient federal basis to deduct a loss but insufficient California basis for the same loss. Or vice versa. Tracking two sets of basis numbers is tedious but necessary — especially for real estate partnerships with accelerated depreciation, partnerships that took advantage of federal bonus depreciation provisions California didn’t adopt, and partnerships with Section 179 deductions where California limits differ from federal limits.

If you’re selling a partnership interest, California basis directly affects the gain or loss calculation on the California return. Getting this wrong means either overpaying tax or underreporting income — neither of which is a good outcome. Our distributions and contributions guide covers the federal basis mechanics in more detail.

Common California Partnership Filing Mistakes

We see the same errors come through our office repeatedly. The LLC fee catches the most people — they budget for income tax and forget that California charges a fee based on gross revenue. A business with thin margins can owe $6,000 in LLC fees on $1 million of revenue even when actual profit is only $50,000.

Missing the nonresident withholding requirement is another frequent problem. If your LLC has out-of-state members and you don’t withhold or get consent forms signed, the FTB can come after the entity for the tax, plus interest and penalties. This isn’t theoretical — it happens.

Forgetting to make the PTET election on the original timely-filed return is expensive because you can’t go back and make it on an amended return. The election window is narrow and unforgiving. Calendar-year partnerships need to make the election by the original due date of Form 565 or 568 (March 15, or September 15 if extended — but the election itself must be on the original return).

Filing Form 565 when you should be filing Form 568 (or vice versa) causes processing delays. General partnerships file 565. LLCs taxed as partnerships file 568. Limited partnerships file 565. It’s not complicated once you know the rule, but we’ve seen returns rejected because the wrong form was used.

Finally, many partnerships neglect to update their California filing when ownership changes. A new partner, a departing partner, a change in profit-sharing percentages — all of these affect the K-1s and potentially the LLC fee calculation. Keep your partnership records current.

Planning Considerations for California Partnerships

Entity selection matters more in California than in most states because of the LLC fee. A general partnership avoids the $800 minimum tax and the gross-receipts-based fee entirely. The tradeoff is liability protection — general partners have unlimited personal liability. For many businesses, the liability protection of an LLC is worth the cost. But for some low-revenue professional practices, the math favors a general partnership or even an LLP.

The PTET election should be modeled annually. Tax rates change, partner circumstances change, and the benefit depends heavily on each partner’s overall tax picture. A partner who moves from California to a no-income-tax state mid-year creates complications. A partner who has large capital losses might not benefit from the credit. Don’t set it and forget it.

Multi-state partnerships should coordinate California filing with other state filings. If the same income is taxed by California and another state, partners may be entitled to credits on their resident state returns — but the credit calculations differ by state, and the PTET election can interact with those credits in unexpected ways. Our services page covers how we approach multi-state planning.

Real estate partnerships in California should pay particular attention to depreciation conformity. California hasn’t always followed federal bonus depreciation rules, and the differences affect both current deductions and future gain on sale. Getting the California basis right from year one saves significant headaches when the property is eventually sold or refinanced.