California is a notoriously bad state to do business in. Regulations, worker’s compensation, and tax issues overwhelm companies. Seeking relief, many incorporate in Nevada. Unless done carefully, this decision can lead to disaster.
Doing Business – Jurisdiction
Jurisdiction is a legal term used to define who has authority over something. Applied to this article, the term refers to the issue of which state has the right to regulate a business. In California, the issue boils down to whether you are considered to be “doing business” in the state.
California is one of the most aggressive states when it comes to defining jurisdiction. If you maintain offices or have employees in the state, you are considered to be doing business here. You must register with the state and pay taxes even if incorporated in another state. This tends to make incorporating in Nevada an expensive option since you have to pay fees twice.
If you are caught “doing business” in California without having registered, you can be in for a rough time. Initially, back taxes and fees come due. You are also going to be fined and probably suspended from doing business until an audit can occur. The California Employment Development Department may levy back taxes and penalties. Your bank accounts may be frozen. Let’s look at an example.
The California Franchise Tax Board tends to look at the facts surrounding a particular situation. Assume I own a Nevada entity for the purpose of building websites. I receive e-mail, and snail mail, and work out of my house in San Diego. The tax agency is going to take the position that I am doing business in California. My office is here. I take calls here. I do the work here. This scenario is going to be very difficult to defend. Playing out the scenario, I will probably end up going out of business due to disruptions, stress, and the resulting financial burden.
So, can you use Nevada business entities if you are in California? Absolutely. Typically, you need to use a double incorporation strategy. Essentially, one entity is in Nevada and another in California. One entity provides services to the other through a fair value contract, to wit, you can’t charge $1 an hour for services rendered. The Nevada entity has to have a business license, office, customary payables such as rent, and the typical items you find with any business. This strategy is typically used to hold non-tangible business assets such as intellectual property or patent rights.
California has a brutal business climate. The Governator has promised relief, but an actor making promises is, well, an actor making promises. Using Nevada entities can provide relief to your business as long as they are used correctly.