After you have decided that incorporating is beneficial for your business, some people consider incorporating in states outside of their home state. Most notably, Nevada has been promoted by many "incorporating services" as having incredible benefits as opposed to the client's home state. Other states such as Delaware and more recently Wyoming have also received consideration for incorporating. In some cases, depending on the facts of your business, there are some benefits in forming an out-of-the-home-state corporation in states such as Nevada. However, in the majority of cases the benefits of forming a Nevada corporation is simply a myth and will often be more expensive and troublesome than filing in the company's home state.
Law of the Land: Foreign Entities
This may be a surprise to many, typically, corporations will be governed under California law despite being incorporated in Nevada. Let's assume you do file a Nevada, yet you operate all of your business in California. Under this scenario, you are deemed to be a "pseudo foreign" corporation. If the corporation is a pseudo foreign corporation, California law in many areas will supersede the law of the state where the company was incorporated in. (See California Corporation Code §2115(b)). Therefore, for companies entirely based in California and doing business in California, practically all of the claimed benefits of incorporating in Nevada are out the window. It should be noted that if a Nevada corporation operating in California fails to qualify as foreign corporation, it may be subject to a number of sanctions. (See California Corporation Code §§2203, 2258, 2259).
Nevada v. California
The benefits typically touted by a Nevada corporation are the following: lower costs; tax savings; and greater privacy. But is any of it true? Below we will discuss some of these issues.
Expense: Contrary to what many people believe, it is more expensive to file in Nevada than in California. Here are some of the additional expenses: the initial filing fee is more; the Statement of Information is much more; you will be required to file a Statement and Designation of Foreign Corporation in California; and you will be required to hire a Nevada Agent for Service of Process each year. For large clients, the additional cost (of approximately $500 more) is not a big consideration, but for smaller businesses every dollar counts.
Taxes: The tax ramifications is usually one of the most important reasons for deciding whether to incorporate and where. Nevada's secretary of state website says that Nevada has none of the following: (1) corporate income tax; (2) taxes on corporate shares; (3) franchise tax; and (4) no personal income tax. So how does this actually play out? The bottom line is if you are doing business anywhere other than Nevada, you will still be required to pay taxes in the state where you are conducting business. So if you are operating and generating business in Nevada, this can be a huge benefit, otherwise if you are generating money in California, you are required to pay California's taxes. Furthermore, any income earned by a Nevada business and paid out to a resident of another state will be subjected to the taxation of that state. Therefore, the income passed on to the shareholders of an S-Corporation in Nevada will be taxed at both the federal level and in the state where the shareholder lives (this also applies to other pass-through entities such as LLCs).
Thus, as indicated in the paragraph above, you will not be able to legally gain the Nevada tax benefits if you form a Nevada pass-through entity such as a S-corporation or LLC. However, a Nevada C-corporation can avoid the state taxes (remember that a C-corporation is subjected to double taxation at the federal level). The way a Nevada C-corporation operating in California could be structured to minimize its taxes is as follows: As a C-corporation, your company will be stuck with double taxation at the federal level. Rather than withdrawing the profits from the corporation, keeping the profits within the Nevada C-corporation will allow it to grow free of any state taxes.
Limited Liability Protection: Whether your company has greater limited liability protection in Nevada versus other states is debatable. Many believe that Nevada state precedence makes piercing the corporate veil much more difficult. Whether this is true will depend on the facts of your case and how good your lawyer is, since the test for piercing the corporate veil in both states are substantially similar (both California and Nevada require a showing that a substantial injustice or perpetuation of a fraud occurred). However, in regards to directors and officer liability, Nevada law provides that directors and officers are not liable for any damages resulting from a breach of fiduciary duty unless the breach involved intentional misconduct, fraud, or a knowing violation of the law. (See Nevada Rev. Stat. §78.138(7)).
Jurisdiction: This can be good or bad for your company. If you are operating in California but are a Nevada corporation, the question is which state law takes precedence? As indicated above, in most circumstances, your corporation will be deemed a pseudo foreign corporation and thus be subjected to California's laws. So if you are sued, the lawsuit would likely occur in the California. However, if the plaintiff attempts to pierce the corporate veil, the lawsuit may occur in Nevada, thus the plaintiff would have to face additional expenses to travel to Nevada to try the case. Likewise, you as the defendant would be required to go to Nevada as well. However, if you enter into contracts with others, your contract can include "choice of law jurisdiction" provisions, which require that the contract falls under the laws of Nevada. Similarly, "choice of forum" provisions in your contracts will require your case to be heard in Nevada.
Privacy: Nevada is generally more restrictive than most states in sharing information about its corporations with other states and the government. As such, many celebrities and high profile individuals seeking anonymity often end up incorporating in Nevada. However, both California and Nevada do not require its stockholders to be listed in public records. Further, Nevada does not share information with the IRS unlike California. But if a Nevada corporation conducts business as a pseudo foreign corporation in California, it would be required to disclose the information to the IRS.
© 2006 Michael N. Cohen, Esq.
This article is not intended as a substitute for legal or tax advice. The specific facts that apply to your matter may make the outcome different than would be anticipated by you. You should consult with an attorney familiar with the issues and the laws.
Michael N. Cohen, Esq. is a business and intellectual property attorney and is the principal of the Law Office of Michael N. Cohen, P.C., located in Beverly Hills, California. For more information, go to http://www.patentlawip.com or contact Mr. Cohen at 310-288-4500.
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