Qualifying To Do Business in another State
When exactly are you required to qualify your corporation or LLC to do business in a foreign state. This can be an especially important question for an Internet based business. Qualification requirements vary from state to state, and are usually a part of state statutes or administrative rules. But, all states follow the same basic principle-businesses must qualify in the state if they are engaged in intrastate business in that state. Basically, your business must transact significant business within a foreign state to be required to register as a foreign business. This also means that at least part of your business is conducted entirely within that state’s borders.
Activities such as selling through independent contractors, soliciting or obtaining orders through the Internet (provided the orders require acceptance outside the state before they become contracts) or conducting an isolated transaction that is completed within a short period of time (and that is not one in a series of repeated transactions of the same nature) are not significant enough. Also, simply owning real or personal property, or maintaining bank accounts in the state are not significant enough activities either.
However, having a physical presence in the state, such as leasing or owning business offices or having stores in the state will generally require you to register in the foreign state, Similarly, if your business has a warehouse in another state and you sell and ship from that warehouse to customers within that state, you are engaged in intrastate business in that state. Also, having resident employees will generally require your business to register to do business in that state. This is clearly something to consider when you employee out of state employees in an effort to outsource.
In general, Internet based businesses that only solicit and accept out of state sales will not have to register as a foreign entity. So, if you sell and ship merchandise from your home state to residents in other states, you will not be required to register (or pay taxes). However, there are many factors used to determine whether a company is transacting business in a state, depending on the different state statutes. Some states exempt certain types of business from having to qualify to do business in that state.
Here are some examples of the types of business activities that out-of-state corporations and LLCs can conduct without having to qualify in most states:
- Mail order or telephone sales, if they are the only business activities the company engages in within a state;
- Maintaining a website, if the website is the only presence you have in other states;
- National (not local) advertising campaigns to customers in that state;
- Selling through independent contractors in that state.
If you sell to out of state customers or transact business in a certain state, you need to review (or preferably your attorney) the relevant state’s statutes to determine what activities trigger qualification.
Even if you do not register as a foreign entity, the business may still be required to file an income tax return if it generates substantial revenue with the state. This determination varies from state to state and is a matter of state statute or administrative regulations. If your business establishes either a physical presence or an economic nexus with a foreign state, it may be liable for state income taxes on revenues earned in the state.
Essentially, this is a way for the foreign state to tax your business for doing business with its residents and squeeze your business for more fees. You will be required to pay a filing fee for registering as a foreign corporation or LLC and must file the proper paperwork with the Secretary of State. Each year you will be required to file annual reports and pay annual fees also as a foreign corporation or LLC.
Registration or qualification of a foreign corporation must and should take place as close as possible to when the corporation starts doing business in another state. Many states also require a Certificate of Good Standing (also called Certificate of Authorization or Certificate of Existence) to be filed by a foreign corporation along with the Statement or Registration described above.
Penalties and other consequences will apply for failure to qualify and register to do business in another state. Possible consequences, depending upon the state, include:
- Monetary fines assessed against the corporation or LLC;
- Monetary fines assessed against the LLC or corporation’s officers, directors, members, managers or its agents;
- Denial of the right to enforce contracts and other civil proceedings in the state courts;
- Personal liability of the LLC or corporation’s officers, directors, members, managers or its agents for the acts of the LLC or corporation in the state.
If your business actually conducts business in more than one state like many Internet businesses, it may make sense to organize in a foreign state.
Consider the filing fees
Each state will charge a filing fee for the privilege of organizing your business entity in that state. Depending on the business type and state, these fees differ widely. Some states, such as Indiana, Florida and Colorado charge under $100 to organize either a corporation or LLC. Some states, such as my home state of Illinois, charge $500 to organize an LLC, but $150 to form a corporation (series LLC’s usually cost more to form). These fees vary and so do the required annual report fees you will have to pay each year no matter what entity you form or where you form it. (You should probably take a look at a comparative table of state filing fees for both corporations and LLC’s to get an idea of costs).
You should also factor in the fees required to file any annual reports or similar required annual filings. Almost every state requires that each LLC or corporation organized under its laws file some type of annual report or pay some annual franchise tax or other fee. Even non-profit corporations are charged some nominal yearly fee. Franchise taxes are discussed in more detail below as a separate factor to consider.
But, if your only goal is to save a buck or two and chose the state with the lowest filing fees, this is the wrong approach. If you organize in one state and end up conducting most of your business in a different state, you will have to qualify to do business in the state you operate within. This means you will have to pay a filing fee to register as a foreign entity seeking to do business in the state along with the initial filing fee you paid to organize. It also means you will pay annual reporting fees/franchise taxes in both states. Often, these fees can be greater than the initial filing fee of the state you organize under.
For instance, if you reside in Indiana or Colorado or some other state with low filing fees, but will conduct most of your business in a state such as Illinois, the low filing fee in another state won’t matter since you will have to register to do business in Illinois. If you form an LLC, this means paying the $500 foreign registration fee Illinois charges and annual reporting fee of $250 per year.