Incorporating a business out-of-state can help you expand the business to other states, protect privacy, and find better investment opportunities. Before you do so, it’s important to understand the requirements involved.
In today’s blog post we’ll help you prepare for this move by sharing information on requirements for out-of-state incorporation, costs and benefits to consider, and a guide on how to register your business in another state.
What Are the Different Business Entity Structures?
The structure of your business entity determines the requirements you need to meet for out-of-state incorporation. The following are the most common business entity types in the United States.
This type of corporation is treated as an independent legal entity and tax structure from the owner.
Being a C Corporation helps separate your personal assets from your business debts, as you can’t be held personally liable for debts incurred by the corporation.
In a C Corporation, there is no limit to the number of shareholders. The shareholders then elect a board of directors, and these directors then designate the CEO to be in charge of managing business operations. You must also hold annual meetings and record meeting minutes.
When it comes to taxation, a C Corporation is taxed separately from the owner on corporate profits. Owners would then pay another tax on shareholder dividends distributed out from the corporation. This is normally called a "double taxation" on corporate profits.
An S Corporation is any private corporation eligible to operate under Subchapter S of the IRS Code. It incorporates, like any other corporation, by filing Articles of Incorporation with the Secretary of State, then choosing directors and officers who oversee the management of the company. A special filing will then be made with the IRS to designate the corporation to be treated as a S Corp.
Similarly to a C Corporation, an S Corporation is treated as an independent legal entity and tax structure, separate from its owners. This helps secure your personal financial assets, as they can’t be seized to satisfy business liabilities.
However, unlike in a C Corporation, S Corporation owners report their share of profit and loss in the company on their personal tax returns. There is no taxation at the corporate level; profits and losses are passed through to the individual shareholders to be reported on their tax returns.
Another difference is that there are limits on the number of shareholders and they must be US citizens or residents.
Additionally, an S Corporation must hold annual meetings and record meeting minutes.
Limited Liability Corporation (LLC)
A Limited Liability Company (LLC) is a hybrid business structure that combines the characteristics of a corporation, a sole proprietorship, and a general partnership.
An LLC offers the tax advantages of non-corporate structures with the limited liability protection of a corporation.
Like C and S Corporations, an LLC is treated as an independent legal structure separate from its owners. As an owner, you are shielded from being held personally responsible for LLC debt.
In terms of taxation, if the LLC has only one owner, it is taxed similarly to a sole proprietorship. If there are multiple owners, the LLC will be taxed as a partnership. One can also have the option to be taxed as an S Corporation or C Corporation.
In an LLC, there is no limit to the number of owners, you are not required to hold annual meetings or record minutes, and the business is governed by operating agreements.
Sole Proprietorship and General Partnerships
Sole Proprietorship and General Partnership are very similar types of business structure, the major difference being the number of owners.
A Sole Proprietorship means there is only one owner, while a General Partnership has two or more partners.
This type of business is easy to form and operate, so much so that, for example, no state filing is required when forming a Sole Proprietorship. However, the biggest drawback is that the owner(s) remains personally liable for lawsuits filed against the business.
Regarding taxation, it is the owner(s) who reports business profit and loss on their personal tax return.
4 Reasons for Incorporating Out-of-State
Incorporating your business out of state can bring a handful of benefits, including lower taxes, a better-regulated business environment, stronger privacy, and opportunities for getting investors.
Having an out-of-state business will help get your tax costs under control. This is important for startup founders, as reducing tax costs can be a significant saving in the early stages of your business.
Another thing to consider is that taxes vary from state to state. For instance, in Nevada, there is no state income tax.
TIP: We recommend you seek legal advice on your taxes to understand whether or not incorporating out-of-state represents a tax advantage in your case.
2. Business Law
In addition, with the advantages of possible reduced tax costs, some business owners choose to incorporate out-of-state for the sake of better-regulated business processes. The states best known for this are Delaware, Nevada, and Wyoming.
Delaware is known for fast and efficient corporate administration. It has a well established and highly respected Court of Chancery that focuses on resolving corporate disputes.
The Court of Chancery is a non-trial court that focuses solely on businesses and examines issues involving real property and commercial litigation. It consists of judges only, with no juries. This court allows business issues to be resolved quickly by a judge who specializes in corporate law and has expertise in resolving complex corporate disputes.
Meanwhile, there are two important ways Nevada business laws can help companies that incorporate there:
- Nevada could help protect your company from large, complicated lawsuits.
- Nevada provides protection, for you and your shareholders, against “piercing of the corporate veil.” When a court pierces the corporate veil, the corporation’s actions are linked back to its shareholders and other accountable officers. These individuals can then be held accountable for acts of fraud or other liability.
Nevada business laws are based off the Delaware model.
Some business owners decide to incorporate their business out-of-state in order to protect their privacy. As each state has its own requirements about the information it collects, entrepreneurs typically go to states that keep private information off the public record.
In states such as Delaware, Wyoming, and New Mexico, beneficial owner information, such as the true name of the business owner, are not disclosed.
For example, Delaware LLCs are not required to list member names and addresses in their filings. Members and managers are only specified in the LLC’s operating agreement, which is private by nature. Therefore, ownership and management information is not recorded and is not available as a matter of public record. Corporations can also be filed without listing shareholders, directors, or officers on the public record if you were to make use of a third-party incorporation service.
For a new company looking to attract outside investments from angels, venture capitalists, and private equity firms, incorporating in well known states such as Delaware will offer a better environment for raising capital.
If you were to select Delaware some investors prefer, and sometimes require, that your company is in Delaware due to the state's business-friendly laws. Additionally, investors normally have a better understanding of and are more comfortable with the Delaware legal system.
What Does it Mean To Do Business Out-of-State?
Doing business out-of-state means doing business outside the state in which your business was originally incorporated.
So, if you originally incorporated your business in California, you are doing business out-of-state if it’s anywhere outside of California.
Here are the activities which are treated as doing business in a given state:
- Operating out of or having a physical presence in that state.
- Frequently conducting in-person meetings with clients in that state.
- Deriving significant portions of the company's revenue from that state.
- Having employees work in that state or having to pay state payroll taxes.
- Having or applying for a business license in that state.
How Do I Register a Business Out-of-State?
If you are considering registering a business out-of-state, you must meet certain requirements. These depend on the type of business structure you have and the state in which you want to register.
A Sole Proprietorship or General Partnership does not have to register with the state. However, all other business entity types need to qualify to do business out-of-state.
When you decide to operate out-of-state, there are a few options. One option is to move your business to the new state by either closing or reorganizing your existing business. This has tax consequences and is generally more complicated. Consult a CPA on how best to approach this. It's a good option if you plan to move your entire business out of the original state.
Another option is to continue operating in your old state and register as a foreign entity in a new state. This option is more expensive as it requires you to file and pay corporate taxes and franchise fees in both states. It is also easier to do. It would also be the only option if you are opening offices or hiring employees in both states. Let’s take a look at how this option works.
What is Foreign Qualification?
Generally, the Foreign Qualification process is taken care of at the time of formation.
If a company is going to conduct business outside of its state of formation, then it must register to do so as a foreign entity in the other states. This process is known as foreign qualification. For example, a business incorporated in Nevada that wants to do business in California would be considered a foreign corporation in California. As a result, the Nevada corporation must qualify as a foreign corporation to do business in California.
The definition of conducting business varies by state and often covers a broad spectrum of activities. Common reasons why businesses foreign qualify include:
- Hiring an employee who is a resident of a state other than the state of incorporation.
- Purchasing property or a building.
- Opening a new office or other facility.
- Offering services, selling products, or bidding for a contract.
- Applying for a professional license.
What is The Foreign Qualification Process?
The Foreign Qualification process is different from state to state, meaning you may have to file different documents in different states in order to foreign qualify your corporation or LLC in multiple states.
When you foreign qualify a Certificate of Good Standing is often required when registering to do business in other states. States will typically require you to file the following:
- An application of Certificate of Registration or Certificate of Authority to foreign qualify your company.
- A fee to file your application.
- A copy of your company’s Certificate of Formation or Incorporation.
- A Certificate of Good Standing or Certified Copy from the state of formation.
What is a Certificate of Good Standing?
A Certificate of Good Standing is a state-issued document that shows that your corporation has met its statutory requirements and is authorized to do business in that state. Think of it as a kind of 'snapshot' of your business's compliance status.
Among other things, a Certificate of Good Standing confirms that your business:
- Is up-to-date on its state fee payments.
- Has filed an annual report.
- Has paid its franchise taxes.
What Else Do I Need For Foreign Qualification?
To qualify you need to have a registered agent in the state in which you are filing for Foreign Qualification.
This registered agent needs to have a physical address (no PO Box) in the state where your business is registered. They also need to be available at the address during normal business hours to receive legal documents.
Once you’ve chosen your registered agent, you need to complete paperwork with the new state’s office of Secretary of State.
If your corporation or LLC is registered to do business in another state, you must obtain a business license and pay taxes so your entity is legal and compliant.
Finally, you need to pay an initial filing fee. Afterward, you will be responsible for filing annual reports as well as taxes in the state in which you have filed for Foreign Qualification in addition to your company's domestic state.
Foreign Qualification in Practice
Now that you have understood the procedure, let’s have a look at several situations that require foreign entity qualification.
Let’s say you have a retail store in Utah and decide to expand into California and Nevada. Before you can open and operate locations in those states, you’ll need to file for foreign qualification in both California and Nevada.
In the next scenario, you incorporated your business as a Delaware LLC but you are physically located in California. In this case, you’ll need to file for foreign qualification to conduct business in California.
Finally, let’s say you are physically located in California and you want to hire out-of-state employees in Nevada, even though you don't have any offices there. You would need to register as a foreign entity in Nevada, but your address would still be in California.
Incorporating your business out-of-state can be a good decision for tax advantages, stronger business laws, higher protection of privacy, and expansion of the business. Carefully consider all the advantages and disadvantages for your business before making this decision.
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