A lot of entrepreneurs wonder what state should be used to incorporate a new business. Is it their own state or maybe another state like Delaware or Nevada? There is no easy answer to that question, however, there are definite benefits for some businesses to incorporate in states other than where they conduct business.

Some existing businesses may also consider registering out of state due to compliance considerations that arise from multistate business activities or employees.

These two different situations result in what is called foreign qualification. Foreign qualification is simply the process of registering to do business in another state.

Let’s look at some examples of why you might incorporate out of state and then we’ll review a few situations that will require you to register a foreign qualification.

Why People Consider Incorporating Out of State

Many people choose to incorporate their businesses in a state other than where they live. There are a few reasons business owners do this:

1. Money Savings

Business tax rates and fees vary by state, and some states are known for their high filing costs. Conversely, some states are known for their business-friendly environments, such as Delaware, Nevada, and Wyoming.

For example, to incorporate in California, businesses must file Articles of Incorporation for $100, plus a $15 handling fee and company bylaw documents, which means additional fees. Corporations must also pay a minimum annual tax of $800 to the California Franchise Tax Board.

On the other hand, in Delaware, the fee to incorporate is $89, which includes a Division of Corporation fee of $50, a filing fee of $15, and a county fee of $24. Plus, if you incorporate in Delaware but do not live there, you do not pay state income tax.

2. Business-friendly Laws

Many large corporations often form in Delaware due to its pro-business reputation when it comes to the courts. Judges with expertise in corporate law hear corporate cases and business laws tend to be more flexible there.

3. Privacy laws

Information collection requirements also vary by state, with some states, such as New Mexico, Nevada, and Wyoming, not requiring ownership information to be made public.

Foreign Qualification Examples

As a reminder, foreign qualification is simply the practice of registering your business in the state to conduct business. It can be tricky to know if this is needed, so let’s review a few examples of where a foreign qualification would apply.

One-Person Business

If you incorporate your business in a different state and you are its sole owner and employee, you still must file for a foreign qualification in your home state.

States base the definition of “doing business” on a variety of factors, but in general, if the business can answer yes to any of the following, foreign qualification is necessary:

  • Will the business have a physical presence (office space, warehouse, or retail store) in the state?
  • Will the business conduct in-person meetings with clients or customers in the state?
  • Is the business structured as a limited liability company (LLC), corporation, or limited partnership (LP)?
  • Will the business have any employees living/working in the state?

LLCs and corporations are considered “domestic” only in their state of formation. Consequently, both LLCs and corporations must foreign qualify in any other state where they conduct business. States require “out-of-state” businesses to register so consumers can be protected.

Employees Working in Multiple States

What about businesses with employees in another state or many states? Again, the test of what constitutes doing business comes into play.

If your workers are actual employees of the business (and not contractors or freelancers), then your company must register for foreign qualification. The business must also register to pay payroll taxes on those employees with the state’s tax agency.

Therefore, in addition to your business’s employer federal payroll tax responsibilities, you must withhold state taxes from the wages of employees living in states with personal income tax. Your accountant or payroll service can help you make the withholding process easy to organize. (Learn about at Payroll Taxes 101.)

Similarly, if the out-of-state employees sell a product or service in their states, you’ll need to register to pay sales taxes in those states as well. Not all states charge sales tax, so make sure you check first. (For more information, see my recent article called What You Need to Know About Collecting Sales Tax.)

If your business is structured as an S Corp and you are doing business in another state, you are required to pay your portion of any payroll taxes due in those states. And again, you need to foreign qualify and register to pay payroll taxes.

Be aware: Some states have reciprocal agreements where you are not required (in the business’s home state) to withhold income tax from the other state. Check ahead of time to find out which states have reciprocal agreements and, of course, CorpNet is here to help.

When Not to Foreign Qualify

Because not all business tasks qualify as “doing business,” it’s essential to analyze your business operations before starting the foreign qualification process. For example, some online businesses are not expected to foreign qualify if all services are conducted online. But if there’s an employee in another state fulfilling the service, you must register.

Most states do not consider the following business activities as transacting business:

  • Being involved in a lawsuit
  • Conducting internal corporate business, such as attending member meetings
  • Opening a bank account in the state
  • Using independent contractors
  • Collecting debts
  • Performing an isolated transaction

Understanding the Foreign Qualification Process

To foreign qualify, you must start the registration process with the Secretary of State’s office in the other state. You’ll be required to turn in a Certificate of Authority application form and pay the state fees. Be prepared to prove good standing in your home state. Your home Secretary of State’s office can supply the Certificate of Good Standing documentation and CorpNet can help if needed.

Make sure the business name is legally available in the other state, or you will have to file a “fictitious name” (or Doing Business As) in that state.

Once you’ve registered, you’ll need to appoint a registered agent. A registered agent is a person or company you have given authority to represent your business in those other states for responsibilities, such as accepting legal documents and government notices.

Registered agents also handle other in-state duties such as:

  • Official state and federal communication
  • Subpoenas
  • IRS tax notices
  • Lawsuits
  • Summonses
  • Corporate filing notifications

Failing to foreign qualify could lead to hefty fines and back-payment of taxes.

Feeling Overwhelmed? Don’t Be!

You don’t have to feel overwhelmed by the process of incorporating out of state or requesting a foreign qualification. If you are interested in forming a new business or foreign qualifying your existing business, CorpNet is here to help.

To order services online, just head on over to the following items and we’ll help you at each step of your process:

Remember you can request assistance online 24/7 or you can call our offices at 888-449-2638 and we’ll walk you through the process.