Myths Regarding Entity Formation
As corporate and transactional lawyers, we regularly assist clients in forming legal entities for their businesses, including corporations and limited liability companies. Often clients request that their entities be formed in a jurisdiction outside California because they have been told that certain benefits can be obtained by doing so. Most of those perceived benefits are false or overstated.
This article focuses on myths associated with incorporating in Nevada, as opposed to California, because we see that most often. It assumes that most, if not all, corporate shareholders are California residents and that the corporation will transact business, in whole or in part, in California.
The first myth is that incorporating in Nevada avoids California franchise taxes. California’s franchise tax is imposed on corporations operating in this state regardless of the state in which they are incorporated. Indeed, foreign corporations that transact business in California are required to register with the California Secretary of State to qualify to conduct business in California. A foreign corporation may not transact intrastate business in California without first obtaining from the Secretary of State a certificate of qualification to transact intrastate business. Qualification necessarily brings the foreign corporation to the attention of the California Franchise Tax Board. The failure to qualify can lead to severe fines and penalties, the voidability of California contracts and the suspension of any right to conduct business in California.
The second myth is that incorporating in Nevada avoids income taxes. California residents must file California tax returns and pay California income taxes on any income no matter where it is earned. That includes income earned in Nevada or from entities formed outside California.
The third common myth is that Nevada affords privacy protections. The fact is that the annual reporting and disclosure requirements for corporations are very similar in California and Nevada. And neither state requires the corporation to disclose the identity of its shareholders. Further, the IRS shares information with California regarding Nevada corporations that conduct business in California.
Fourth, there is the false perception that Nevada provides greater protection to corporate officers and directors. However, California and Nevada laws are very similar on this issue. In any event, a Nevada corporation whose shareholders are primarily California residents and that operates in California, likely qualifies as a “quasi-foreign” corporation under California law. That means that the Nevada corporation and its shareholders are subject to many California laws, regulations and jurisdiction. Thus, incorporating outside the state often merely results in a corporation having to comply with the laws of multiple jurisdictions instead of one.
Lastly, there is a common myth that it is cheaper to incorporate in Nevada. The fact is that it may be more expensive for a business conducted in California to incorporate in Nevada. The initial filing fee and the annual maintenance fees for corporations are higher in Nevada than in California. And as mentioned above, foreign corporations that conduct business in California are required to register with the California Secretary of State. As such, the foreign (Nevada) corporation then is also subject California’s fees so in effect it pays fees in both states.
If you need legal advice on entity formation, see a competent and experienced lawyer. The lawyers at the Capobianco Law Offices have the practical experience and expertise to guide you on all business and entity formation matters.