Yes, it is indeed possible for a resident of California to establish an LLC or S-Corp in another state. However, there are certain considerations and potential complications that must be understood to make an informed decision.

This article will delve into the topic of starting an LLC or S-Corp in another state, examining the legal requisites, tax implications, and other critical factors.

Understanding the Basics of LLCs and S-Corps

What is an LLC?

An LLC, or Limited Liability Company, is a type of business structure in the United States that combines features of both a corporation and a partnership. It provides its owners, called members, the benefit of limited personal liability for the debts, liabilities, and obligations of the company, similar to shareholders in a corporation. However, unlike a corporation, an LLC is not required to have a board of directors or hold annual meetings, making it a more flexible option for small businesses.

What is an S-Corp?

An S-Corporation, commonly referred to as an S-Corp, is a unique form of corporation in the United States that aims to circumvent the issue of double taxation faced by regular C corporations. This specialized entity is specifically designed to alleviate the burden of being taxed twice while maintaining its legal status as a corporation. S-Corps enable the direct passage of profits, and in some cases, losses, to the personal income tax returns of owners. This advantageous structure not only ensures tax efficiency but also maintains the integrity of the original financial outcome. Not all corporations are eligible for S-Corp status, as it is limited to domestic companies with no more than 100 shareholders who are citizens or permanent residents of the United States and may only have one class of stock.

Why Choose Another State for Your LLC or S-Corp?

There are several reasons why an entrepreneur in California might choose to form an LLC or S-Corp in a state other than where they reside and will operate their business.

Favorable Business Laws and Regulations

The primary motivator often revolves around favorable business laws and regulations that some states offer. For instance, Delaware, Nevada, and Wyoming are popular for their business-friendly statutes, low filing fees, and limited bureaucracy.

Perceived Reduction in Taxes

Another reason might be the perceived (although often misguided) potential for reduced taxes. Some states have no corporate or personal income tax, while others may offer lucrative tax breaks for certain types of businesses.

Privacy Protection

Additionally, choosing a state other than California might provide superior privacy protection, since some states do not require the disclosure of member or owner information.

Increased Business Credibility

Finally, some entrepreneurs may form an LLC or S-Corp in another state to improve the credibility of the business by associating it with a well-regarded business hub.

The Process of Starting an LLC in Another State

To set up an LLC or an S-Corp in another state, the following basic steps are typically involved, although these are very broad strokes and the laws of specific states should be consulted before forming any business entity.

Choose a Name

You need to select a unique name for your company that is not already in use by another entity in your target state.

Appoint a Registered Agent

A registered agent is a person or business entity responsible for receiving legal papers on behalf of your company in the state of formation.

File Formation Documents

These are typically called “Articles of Organization” for LLCs and “Articles of Incorporation” for corporations, but these documents may go by names such as “Certificate of Organization” or “Certificate of Incorporation” depending upon the state in which founding documents are to be filed.

Create an Operating Agreement for an LLC or Bylaws for a Corporation

For an LLC, an Operating Agreement outlines the ownership and operating procedures for the limited liability company.

For an S-Corp, bylaws provide the rules governing the operation of the S-Corporation.

Obtain an EIN

An Employer Identification Number from the IRS is needed for tax purposes, to open a business bank account, and many other purposes.

Complete All Other State Requirements

It is critical to note that the requirements for forming an LLC or S-Corp can vary significantly from state to state. Different states may have unique requirements regarding annual reports, state-specific tax forms, permits, and licenses. Therefore, while the above-listed steps provide a general guide, it is essential to understand and comply with all other regulations, rules, and procedures specific to the state in which you are forming your LLC or S-Corp.

Failing to meet any of these requirements could result in legal complications, fines, or even dissolution of your company. It is often advisable to consult a business lawyer or a professional formation service to ensure that you meet all state-specific requirements.

Foreign Registration Requirements in California

Once you have formed your LLC or S-Corp in another state, California laws and regulations often require that you register this foreign entity with California. This is known as Registration for Authority to Transact Business in California.

When Must a Foreign LLC or S-Corp Complete a Registration for Authority to Transact Business in California?

It is crucial to understand when a foreign LLC or S-Corp must register in California. The state has specific rules and regulations that detail when a business is considered to be conducting transactions within its jurisdiction, thereby necessitating registration. While we have addressed this topic in depth on this page of our website as well as in this other article, below are some highlights.

Foreign Registration Required Based on Sales Revenue in California

If an LLC or S-Corp is established outside of California but has sales within California that exceed either $500,000, or 25% of its total sales, that LLC or S-Corp must complete Registration for Authority to Transact Business in California.

Foreign Registration Required Based on the Value of Property Located in California

If an LLC or S-Corp formed outside California owns real property or tangible personal property located in California exceeding $50,000 in value, or 25% of the value of all its real property and tangible personal property, the company must complete a Registration for Authority to Transact Business in California. This applies even if the business does not physically operate in California.

Foreign Registration Required Based on Compensation Paid to California Residents

If an LLC or S-Corp that is established outside of California pays compensation within the state that exceeds $50,000, or 25% of its total compensation, it must complete a Registration for Authority to Transact Business in California. This rule applies even if the organization does not have a physical presence in California. This compensation could be wages, salaries, commissions, or any other form of remuneration paid to employees for services. F for pass-through entities such as LLCs and S-Corps, this compensation includes distributions made to owners who reside in California even if the business is legitimately conducted outside of California.

Cost of Registration and Foreign Registration for Out-of-State LLC or S-Corp

If a California resident or a California-based business decides to form an LLC or S-Corp in another state despite meeting the criteria discussed above or other reasons requiring a Registration for Authority to Transact Business in California, they should first understand the initial setup costs for doing so and weigh these against the benefits they believe they will get from starting an LLC or S-Corp outside of California.

Formation Costs for an LLC or S-Corp Outside of California

Forming an LLC or S-Corp involves costs regardless of the state where you decide to establish your business. These costs can be related to filing the necessary documents, such as the Articles of Organization or Incorporation.

Also keep in mind that you will be required to have a registered agent in the state in which you form an LLC or S-Corp, so unless you have an office out of state, or a friend willing to assist you in that state, you will have to pay anywhere from $50 to $500 for a registered agent in that state before filing paperwork there.

Registration for Authority to Transact Business in California Costs for an LLC or S-Corp

The filing fees for Articles of Organization or Articles of Incorporation in California are the same as the filing fees for Registration for Authority to Transact Business in California. However, these will be in addition to whatever filing fees were paid to the state outside of California for the original formation. So instead of paying the registration fees and costs in just one state, you will end up paying the formation costs in the state of formation and the California filing fees and other costs of the Registration to Transact Business in California. This duplication of fees and costs will increase, and could potentially double, the upfront cost depending upon the filing fees in the other state of formation and the California fees.

Annual Maintenance Costs for an LLC or S-Corp Formed Outside of California

Similar to the considerations of initial startup costs, above, it is also important to understand the annual maintenance costs involved in forming an LLC or S-Corp outside of California.

Annual Maintenance for LLCs and S-Corps Outside of California

The annual maintenance for LLCs and S-Corps formed outside of California will depend on the specific jurisdiction in which the entity is formed. These maintenance obligations typically include filing annual reports and other necessary documents to maintain good standing with the state.

The nature and frequency of these filings and the associated fees can vary considerably from one jurisdiction to another. For example, some states may require a comprehensive annual report based on the financial performance of the company, while others may only require a simple confirmation of the continued existence of the company. Regardless, there is generally a recurring fee that must be paid annually, and this fee varies from a nominal fee in some states to several hundred dollars annually in other states.

Unless you have an office out of state, or a friend willing to assist you in that state, also keep in mind that you will have to pay anywhere from $50 to $500 annually for a registered agent in the state in which your LLC or S-Corp was formed.

Annual and Biennial Maintenance for Foreign LLCs and S-Corps in California

In addition to the annual requirements and associated fees from the state where an LLC or S-Corp is formed, California also has annual or biennial filings that must be completed for foreign LLCs and S-Corps with Registration to Transact Business in California. As you will read below, these filing fees are not expensive and the filing requirements are not onerous, but keep in mind they are in addition to the annual requirements from the state in which the LLC or S-Corp was formed.

Biennial Statement of Information Filing for LLCs in California

Every two years, an LLC operating in California is legally obligated to file a Statement of Information with the California Secretary of State. The Statement of Information must be filed and failure to comply with this requirement can lead to penalties and potentially the suspension of the authority to transact business in California. The biennial filing fee is $20 to file a Statement of Information.

Annual Statement of Information Filing for S-Corps in California

Every year, an S-Corp operating in California is legally obligated to file a Statement of Information with the California Secretary of State. The Statement of Information must be filed and failure to comply with this requirement can lead to penalties and potentially the suspension of the authority to transact business in California. The annual filing fee is $25 to file a Statement of Information.

Annual Business Tax Implications for Starting an LLC and S-Corp Outside of California

Regardless of where you establish your LLC or S-Corp, it is crucial to understand that all states levy some form of annual tax against these entities. The terminology used to describe these obligations can vary, with some states referring to them as taxes while others may categorize them as a state business license or similar designations.

Annual Taxes for an LLC or S-Corp Outside of California

Regardless of the nomenclature, the tax liabilities for an LLC or S-Corp established outside of California will depend on the specific tax laws of that state.

Some states may impose a flat fee, while others base tax obligations on the net income or gross receipts of the company.

However, even if your business is formed in a state with more lenient business tax laws, you must remember that as an LLC or an S-Corp with the authority to transact business in California, you will still be subject to the business tax obligations of California in addition to your foreign state tax liabilities.

California Franchise Taxes for LLCs or S-Corps Formed Outside of California

California Franchise Taxes and California LLC Fees

California requires all LLCs to pay an annual franchise tax of $800 to the California Franchise Tax Board. This tax is due irrespective of income level or activity and is essentially a flat fee charged for the privilege of doing business as an LLC in California.

In addition to the annual franchise tax, a California LLC Fee is also imposed based on the total annual income derived from or attributed to the state. This fee is progressive, starting at $900 for incomes over $250,000, and can go up to $11,790 for incomes exceeding $5 million. This LLC fee is in addition to the annual $800 franchise tax and is determined when the LLC files its California tax return.

California Franchise Taxes for S-Corps

California requires all S-Corps to pay the greater of an $800 minimum or 1.5% of net income annually as a franchise tax to the California Franchise Tax Board. The $800 minimum is due regardless of income level or activity.

Beware of Illusory Benefits for Forming Out-of-State LLCs and S-Corps

Despite the potential for duplicated fees and taxes, forming an LLC or S-Corp outside of California could present tangible benefits for specific kinds of businesses under particular situations. For businesses with a specific strategic outlook, the initial setup and ongoing maintenance costs and increased taxes could be offset by these benefits, making out-of-state incorporation a worthwhile consideration.

However, most businesses will realize only increased taxes and fees with no real benefit from forming outside of California

How to Choose the Right State for Your LLC or S-Corp

Do you need help deciding where to establish your limited liability company or S-Corporation? The intricate details and implications of choosing the right state can be overwhelming, but you do not have to navigate it alone. Reach out to the experienced corporate attorneys at San Diego Corporate Law. With a thorough understanding of corporate law and tax structures, we offer personalized guidance to help you make an informed decision that aligns with your business plans. Contact us today to schedule a consultation and let us simplify the complexities of forming your LLC or S-Corp.