Starting a business in another state is a solution that has taken an almost mythic-like status in online advice pieces – a lot of business analysts sell this solution as some sort of company cure-all, a way to avoid having to sink a business’s hard earned cash into the state treasury.
The reality of the situation, unfortunately, is much more nuanced. In some cases, forming an LLC or corporation in a state other than the one the company primarily does business is a good idea. However there are reasons why tax havens like Nevada are not the state of formation for every single small business looking to save some money.
Before choosing to go out-of-state, business owners should consider the following:
1. There are most likely other fees and regulations to contend with
A business that incorporates or forms an LLC in one state, yet still wants to do the majority of its business in another state, will have to qualify as a foreign business entity in the latter state. So even if a company hopes to save money on taxes by filing paperwork in Nevada or Delaware, it will still have to pay a fee to qualify to do business in its home state.
Annual fees are also typically higher, and in most states a registered agent has to be maintained in the state that the business was formed in, which winds up costing even more money. So even if a business saves a bit of cash on state-levied taxes or fees, it may still wind up paying out-of-pocket simply for setting up in a state other than the one it does business in.
2. Choosing another state may not be right for some types of business
Traditional, brick-and-mortar businesses will typically be better off staying in their home state. Local regulations, fees, and licensing requirements are difficult enough to contend with. Why add all of the extra foreign-registration requirements on top of that?
However, for larger businesses, or companies that expect to do business across multiple states, finding a tax haven may be a good idea as interstate commerce does not typically require a lot of extra paperwork. It really is a matter of where a company expects to do the majority of its business.
If a business hires most of its payroll, or makes most its money, from one particular state, it may not save any money on taxes at all.
3. The state treasury could come knocking
Certain states have laws that go into affect depending on factors like where the majority of a business’s transactions take place or the residence of its shareholders – those laws enforce the home state’s regulations over the state of formation.
This makes some of the benefits of incorporating out of state a moot point. Having to pay foreign qualification fees, registered agent costs, increased annual fees on top of the business’s home state’s income tax and, in some cases, franchise tax, winds up costing much more than if a business simply chose to stay home.
Clearly, for some small businesses, incorporating or forming an LLC outside of its home state may not be a great idea. Choosing a business entity that separates personal assets from business liabilities is a great step, but that can be done easily enough in one’s main state of business, and it will not require the heaps of extra paperwork and fees necessary for a foreign qualification.
Every business has its own unique set of needs, and each state treats foreign entities differently, so meeting with a tax lawyer or accountant is always a great idea if you aren’t sure what to do next.
However, business owners should not expect an out-of-state formation to get them out of paying what the state government believes is due to them.
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