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Introduction
Factors to Consider

Taxes
Costs
Jurisdiction

Some “Corporation-Friendly” States

Delaware
Nevada

California Law Regulating Foreign Corporations

Introduction

One of the first decisions a business must make after deciding to incorporate is where to incorporate.  Since you are not required to incorporate your business in the state in which you operate your business, you may choose any of the 50 states or the District of Columbia as the state of corporation.

Your decision should be based on the numerous factors listed below.  In most cases, the circumstances will show that it is most advantageous and convenient to incorporate your business in the state in which the business operates – the business’ “home” state.

Some states – traditionally Delaware, and more recently Nevada and a handful of other states – have been touted as “corporation-friendly.”  Incorporation services (and even the states themselves) advertise, for instance, that incorporating in Nevada will save taxes, or that Delaware corporation law provides more protection for the corporation’s officers and directors. 

There are two primary factors that generally nullify any apparent advantage of incorporating in other than your home state:

• Your home state’s corporation laws will often be applied to the exclusion of the laws of your incorporating state if the majority of your business is generated in your home state, and

• Incorporating in other than your home state will require you to “qualify” your corporation to do business in your home state. You will then have continuing expenses of maintaining your corporate status in two states at additional expense.

• “Domestic corporation” is a term used by the states to refer to a corporation organized under the laws of that state.
  

• “Foreign corporation” is a term used by the states to refer to a corporation organized under the laws of a different state. For example, a corporation formed in Nevada is considered a foreign corporation by every other state.

Factors to Consider

Tax Considerations

Although the primary characteristics of corporations are similar from state to state, the applicable tax rate is not.  The highest California franchise tax rate applicable to corporate income is 9.3%.  Nevada, on the other hand, has no franchise tax and no state income tax.

Many states have statutes that subject all corporations (foreign and domestic) doing business within a state to the same tax requirements.  For instance, all corporations doing business in California – even if incorporated in another state – are required to file a California corporate tax return.  California law imposes heavy penalties on corporations doing business in California that fail to file.

Out-of-state corporations conducting no business in a particular state may still be subject to that state’s tax requirements.  Again, under California law, if more than 50% of a foreign corporation’s voting stock is held by persons who have addresses in California, the corporation must comply with California corporate law.  Also, any corporation deriving income from sources within California is subject to the California franchise tax.

Cost Considerations

Although retaining an attorney is not required to incorporate your business, seeking legal counsel is advisable due to the complexities of the process.  Thus, if you are considering incorporating out of state, consulting with legal counsel licensed and practicing in the incorporating state may represent an additional cost if you already obtain legal advice in your home state.

Every state requires a corporation to have a resident agent for service of process located at a physical address within that state. Many private service companies offer resident agent services in all states. The typical fees are between $125 and $200 per year.

Finally, many states (including California) require a foreign corporation to obtain permission or certification before conducting business within a state.  This process is usually called “qualification,” and involves filing paperwork with the Secretary of State, and an additional fee. It also imposes the same or similar annual filing or reporting requirements and fee or tax obligations on the foreign corporation as are imposed on domestic corporations.

Jurisdictional Considerations

If a business headquartered in one state is incorporated elsewhere, it will be subject to jurisdiction and service of process in the state of incorporation.

This may prove to be inconvenient for a variety of reasons.  First, subjecting your corporation to service of process in the state of incorporation means that any legal notices and/or communications from the state will be sent to your registered agent in that state.  Materials may therefore be delayed as your registered agent forwards them to you.  Time-sensitive materials, specifically, may be misplaced or may not reach you in time.

Second, subjecting your corporation to another state’s jurisdiction usually means that your corporation is governed by the laws of that state, which may differ from those of your home state.  An important consequence of this is that the court system in your corporation’s state will probably require you to appear in court in that state if any legal disputes arise (for example, if a creditor is attempting to collect a debt owed by your corporation).

Some “Corporation-Friendly” States

Delaware

Delaware has long been touted as the best state in which to incorporate.  In the past, Delaware had the most liberal incorporation statute in the country, which gave management great flexibility in operating the corporation’s business.  This flexibility was a great advantage to huge corporations that do business and have shareholders nationwide (or worldwide); however, this advantage is usually not important for smaller corporations.  Besides, most states have modernized their corporation statutes to make their laws comparable with Delaware.

As discussed earlier in this section, substantial contacts of a business in its home state often requires the application of the home state’s corporation laws, not those of the state of incorporation. Where this principle is followed, the laws of a so-called “corporation-friendly” state such as Delaware will not applied to the resolution of a dispute occurring in the home state of a business.

This is not to say that incorporation in Delaware is not a good idea.  Over half of the Fortune 500 companies are incorporated in the state.  The distinction is that the reasons for Delaware’s popularity among larger corporations are seldom applicable to smaller ones.

Nevada

The Misconception About Nevada Corporations

There is a widespread misconception (unfortunately perpetuated by the misleading advertisements of several incorporation service companies) that there are tax advantages for a California business to incorporate in Nevada since there are no corporate income taxes in Nevada. This is not the case. Incorporating in Nevada will not eliminate the obligation of a Nevada corporation doing business in California to “qualify” as a foreign corporation in California and pay the same fees and taxes as if the business had incorporated in California in the first instance.  The combined expenses will actually exceed what a California business would be required to pay if it simply incorporated in California since the business will have to pay annual fees to maintain the good standing of the corporation in both states. If it doesn’t have a physical office in Nevada, it will probably have to pay additional annual fees of $125 to $200 for a registered corporate agent in Nevada.

This is not just a disadvantage for California businesses. The laws of many states similarly protect its home businesses by requiring foreign corporations to comply with the same requirements for annual filings, fees and taxes on income generated in the state that are imposed on domestic corporations.

According to the Nevada Secretary of State, the following are the advantages of incorporating in Nevada:

 

Many of the non-tax claims made by the Nevada Secretary of State are the same in the corporation laws of many states, including California. For example, directors are not required to be shareholders in any state. California does not charge a tax on corporate shares. However, while California imposes a fixed filing fee of $100 to file Articles of Incorporation, Nevada has a minimum filing fee of $175, but the fee may go as high as $25,000 based on the value of the corporation's authorized shares.

The names of shareholders in California and most states are not public record, same as Nevada. Like Nevada, officers and directors in a corporation can be protected against personal liability for the acts of the corporation. Finally, like Nevada, shares in a California corporation, like most states, may be issued for essentially the same types of items (assets) as listed by the Nevada Secretary of State.

In short, there is rarely an advantage for a business located outside of Nevada to incorporate in Nevada. It will not enjoy the "tax-free" status afforded Nevada businesses, but it will be required to qualify as a Nevada corporation in its home state and pay home state corporate taxes. A non-Nevada business will also be subject to the ongoing filing requirements and annual fees imposed by Nevada as well as its home state.

California Law Regulating Foreign Corporations

Requirement to Qualify to Do Business In California

If a foreign corporation conducts intrastate business in California, it must qualify with the California Secretary of State to do business in California (§2105(a)).  To “conduct intrastate business” means to engage in “repeated and successive transactions of business” in California – not simply an isolated transaction (§191(a)).  This analysis necessarily is performed on a case-by-case basis.  There are several activities that do not constitute transaction of intrastate business, such maintaining bank accounts in California, or soliciting orders requiring acceptance outside of California, etc. (§191(b – d)).

If a foreign corporation conducts only interstate or international business, it is not required to qualify to do business in California (§§191(a), 2100).

If a foreign corporation is required to qualify in California, it must satisfy the following:

• The foreign corporation must submit the following to the Secretary of State:
  

  • A “Statement and Designation by Foreign Corporation” form,
    

  • A $100 fee for this filing, and
    

  • An original certificate by an authorized public official of the state of incorporation, to the effect that the corporation is an existing corporation in good standing status in that state (note: the state of incorporation usually charges an additional fee for this).
    

• The foreign corporation must pay at least the minimum franchise tax of $800, and may be subject to the payment of California income tax.

• The minimum $800 franchise tax must be paid in each subsequent year.
  

• It must file a “Statement of Officers” biennially with the Secretary of State and pay a $20 filing fee.

• Per diem penalty. A foreign corporation that has not qualified to do business in California is subject to a penalty of $20 for each day unauthorized intrastate business is willfully transacted, retroactive to the first day such business was transacted (§2203(a – b)).
  

• Fine. Transaction of intrastate business by a foreign corporation without qualification is a misdemeanor.  A fine of $500 to $1000 may be imposed (§2258).
  

• Incapacity to sue.  An unqualified foreign corporation cannot bring an action or proceeding in a California state court on any intrastate business transacted in California (§2203(c)).  This incapacity is removed when the corporation qualifies and pays a $250 penalty (in addition to other qualification fees).  A corporation is not prohibited from defending an action, or bringing a suit in California intrastate business in either a federal court or a court of another state.
  

• Agent’s fine.  A fine of $25 to $600 may be imposed on any person who conducts intrastate business in California on behalf of a foreign corporation that has not qualified (§2259).
  

• Voidability of contracts.  Contracts made by a nonqualified corporation are voidable at the option of the other contracting party (Revenue & Tax Code §23304.1).

1. In what state will the corporation's principle place of business be located?
   
   A foreign corporation that does business in California and maintains its principle office outside the state of California is deemed to be transacting interstate business.  Consequently, the foreign corporation must qualify to do business in California even if the operations controlled from its California headquarters occur entirely outside of California.
   

2. In what state(s) will the corporation be doing business?
   
   A foreign corporation that enters into repeated and successive transactions of business in California must qualify to do business in the state.  A foreign corporation doing business in California is subject to the same taxes as a California corporation.
   

3. From which state(s) will the corporation derive its income?

   A foreign corporation is taxed by California on its net income from sources within the state, whether or not it is doing business in California.

Summary

The discussion above may be summarized by listing three general factors to determine the proper state in which to incorporate:

1. The location of your physical facilities.
   

2. A cost analysis comparing the cost of incorporating in a state other than where the principal office of the corporation is located plus the cost of qualifying as a foreign corporation in one’s “home state.”
   

3. Determining the advantages and disadvantages of each state’s corporate laws and structure.