Doing Business in Multiple States-When Does Your Company Have to Register?

by

Establishing a separate legal entity is step one in separating your and business assets. The next step is to make sure you are in compliance, which can mean many things including compliance from a Secretary of State level, to compliance from a business credit level to compliance at a state taxation level (and federal). All areas are very important. Let’s discuss an area that is not often discussed until it is too late and that considers the multistate taxation rules which will help determine which states your entity will need to register to do business.

In our industry, where Nevada and Wyoming corporations are promoted this is the reason why benefits such as saving state corporate income taxes or privacy rarely comes into play because if you live and do business in another state, the Nevada entity will need to foreign register to do business in that state. At your state level, there may be state taxes and your name and information is probably going to be more exposed. Two important points, first if you are operating as an LLC taxed as an S corporation for example, it is a flow-through entity with no federal taxes paid and in many states, no state taxes. An informational return is required to be filed at the federal and state level (in most cases) and the tax is paid at the owner’s level. This comes into play when someone says, “I live in Arizona and I want a Nevada LLC taxed as an S corporation to save state corporate taxes here in Arizona.” There is not any state taxes on LLCs taxed as an S corporation in Arizona anyway. This is typically promoted in relation to a C corporation which has state corporate taxes in most states but usually is the wrong entity for the small business owner (because of double taxation and the goals of the small business owner, especially a home-based business owner is to have low overhead and high-profit margins). The second point is that privacy is many times overrated because I find there is a common pattern to strive for so much privacy and the basic asset protection is missing. Most do not think it through with capitalization, issuing ownership interest…

Back to the subject at hand, when does your company have to foreign register or qualify to do business in another state? There are two ways to look at this, what does the state say about this at the Secretary of State level and more specifically what does the multi-state taxation rules say about it?

Each state has some basic rules that may help in determining what is considered doing business in their state and therefore state taxes may be due. Let’s take a look at California and Texas. California is one of the highest taxed states in the country. They have an annual $800 minimal franchise tax fee that applies to all entities (there is an exception in year one for corporations). California has a state tax rate for all entities and that is why they spend more time on the California Franchise Tax Board website to let you know what is considered doing business. On this site, https://www.ftb.ca.gov/businesses/faq/734.shtml, the California Franchise Tax Board defines doing business in California as ‘doing business’ means actively engaging in any transaction for the purpose of financial gain. That is a very wide interpretation of what is considered doing business.

Texas does not have a state corporate income tax but they have a franchise tax. The franchise tax is a privilege tax imposed on corporations, including banking corporations and limited liability companies that are chartered in Texas. The tax is also imposed on non-Texas corporations that do business in Texas. The Texas Franchise Tax fee is just a fancy name for state income taxes. But from a marketing point of view if the state can promote it has no personal income taxes and hit the businesses harder that may help them from a political point of view. If you are doing business in Texas, like owning real estate by itself will trigger the Texas Franchise tax fee which Corporations pay the greater of the tax on net taxable capital or net taxable earned surplus. There are two approaches, one is the taxable capital of a corporation’s stated capital (capital stock) plus surplus. Taxable capital for an annual report is based on the end of the corporation’s last accounting period in the calendar year prior to the calendar year in which the report is due. The tax rate on taxable capital is 0.25 percent per year of privilege period. Earned surplus for an annual report should be reported beginning with the day after the ending date on the previous franchise tax report and ending with the end of the corporation’s last federal accounting period in the calendar year prior to the calendar year in which the report is due. The tax rate on earned surplus is 4.5 percent.

There is an easy way that the California Franchise Tax Board will determine if you are doing business in California, they will subpoena your business credit card and look at where the transactions take place. If they are all in California for example, and you formed a Nevada LLC and did NOT register to do business in California you will be subject to the California franchise tax fee plus penalties and interest. From California’s point of view, if you were doing business in Nevada and lived in California, most of your expenses should be where you are doing business. This is a good rule of thumb for any state. Does this mean anytime you go into another state your LLC or Corporation will have to foreign register? No. But more times than not you may be doing business in another state and not be realizing it and be subject to state taxes. The best way to blow this is to hire employees in another state. If you do that the entity will need to foreign register and pay taxes in that state. You may be thinking is having independent contractors an exception? Yes, that does not constitute doing business in another state. Does that mean the solution is just to have independent contractors only work for your company outside your state? No. You must follow the IRS’s test for employees vs. independent contractors. Don’t wait until it is too late to find out you really have employees working for you! Here are the tests: https://www.irs.gov/newsroom/understanding-employee-vs-contractor-designation

When I started NCP back in 1997, several times during the first two years went to speak to Deloitte, the big global tax firm and invested $400-$600 per hour to understand these basic concepts because no one in our industry was addressing these issues or concerns.

read more