This post covers a question we often get from our clients: should a California business incorporate in Nevada?
California can be an expensive state in which to run a corporation. Every corporation is responsible for a minimum franchise fee of $800.00 per year just for the privilege of existing in the state (although this is waived for the first year). That minimum fee is owed whether or not the business makes a dime for the taxable year in question.
To make matters worse, even if a corporation elects S-corporation status to exempt itself from federal taxes, California is one of the few states that taxes S-corporations at the entity level, to the tune of 1.5% of its net income.
With these taxes raising the cost of doing business, it’s understandable for owners to consider setting up shop outside of California. This is especially true with law firms and document filing companies aggressively pushing the supposed benefits of incorporating in Nevada, Wyoming and other jurisdictions where there are no state-level income taxes.
So should your California company incorporate in Nevada or another tax-friendly state in order to avoid state taxes? In nearly all cases, the answer is no. Here are two reasons why it’s a bad idea.
Reason 1: You Probably Won’t Save on Taxes Anyway.
To be clear: a company’s state of incorporation doesn’t by itself determine whether it has to pay taxes to California. In fact, for tax purposes, California doesn’t care if your company is incorporated in California or someplace else. What matters is whether your company is “doing business” in California—basically, whether it has an office or employees, or earns money, in the state. If the answer is yes, then the corporation is “doing business” in California.
Any foreign (i.e., out of state) corporation doing business in California must qualify to do business in the state. Qualifying isn’t difficult—you just file a form with the Secretary of State and pay a filing fee. But once the corporation is qualified, guess what? It will be required to pay taxes on its California-derived income, and will also be on the hook for the minimum annual franchise fee. Failure to properly qualify can have serious consequences, including monetary penalties and being barred from starting or defending a lawsuit in the state’s courts.
So here’s the end result. Your Nevada corporation won’t have to pay any Nevada state income taxes. But if the company is doing business in California (which nearly all California-based businesses will), then it still must pay taxes and franchise fees to California, even if it didn’t incorporate there. The corporation won’t save anything on taxes.
Reason 2: You’ll Spend More Time and Money on Compliance.
In addition to not avoiding California taxes, a California company incorporated in Nevada will have to comply with corporate legal requirements in both states.
In Nevada, this means that every year the corporation will have to prepare and file a list of officers and directors, along with a business license renewal. The fees for these filings are $150.00 and $500.00, respectively. Also, if the company doesn’t have a person who can act as its registered agent in the state, it will have to pay a company to do it, which can cost another few hundred per year. In California, the corporation will be required to prepare and file an annual statement of information at a cost of $25.00. Failure to file these documents on time in either state will subject the corporation to monetary fines, and could also result in suspension by the Secretary of State.
To sum up, a California business that incorporates in Nevada or some other state generally won’t be able to avoid paying taxes to California. And if that wasn’t bad enough, it will have to deal with the burdens and costs of complying with the corporate requirements of two states, instead of just one. So if you’re operating a California-based business, you’re probably going to be much better off just incorporating in California. Finally, while this post focuses mostly on corporations, the same reasoning applies to why a California company should think twice about forming an LLC outside of the state as well.