3 Reasons why it may be a BAD idea to form your business in another state!

Originally published on LinkedIn. 

As an intellectual property and business law attorney in California, I have been getting a lot of questions from people who want to create a corporation or LLC but think they are better off in creating it in another state like Nevada, Delaware, or some other state. I find some of the clients are asking because they misunderstand the information out there that may not apply to Californians. While each of these topics requires comprehensive analysis, here are three good reasons to think twice before you form your business in another state.

For a specific inquiry feel free to reach out to me or a business law attorney in your state. This article as an educational tool to dispel some of the common misconceptions. #CABusinesses #Startups #Entrepreneurs #BusinessStrategy

#1 Reason: Foreign Entity Status

If you are a resident of California or becomes a resident of California and you own a business that was created in another state other than California and “transacting intrastate business in California,”1 you will need to qualify or register that business with California State Secretary. Your entity is considered a foreign entity, as long as it is not an entity formed in California. It is important to understand, the “foreign entity status” does not mean another country, in this context, it means any business that is formed outside of the state where it is doing business, is considered foreign.

Not qualifying or registering as a foreign entity, if you are transacting intrastate business in California carries both civil and criminal penalties, therefore it is important to seek advice from a qualified professional regarding your specific situation. For instance, if you are not registered with California, in which, you are transacting intrastate business, you have limited rights as far as using the courts in California, including but not limited to, limitations on enforcing some contracts in the state, and worse yet subject to criminal penalties.

#2 Reason: You won’t save on tax

Online services, YouTube videos, and articles from random persons sometimes claim to offer savings on tax if you incorporate in a state like Nevada. While Nevada does not have corporate or individual taxes, it does not preclude you from tax obligations to other states, if your business spans to another state(s). In other words, if you are doing business outside of Nevada, you will be subject to tax in other states where you are transacting business. For example, if you are doing business in California, but for tax purposes, you incorporated in Nevada or Delaware, you will not be able to escape your tax obligations to California for the business that is conducted in California.

#3 Reason: Obligated to Multiple Jurisdictions

If you are a corporation that is incorporated in another state, but majority of your corporation’s shares are owned by California residents and you do most of your business in California, then under the law (Corporate Code §2115) your corporation is treated as a “pseudo foreign corporation” and your corporation is treated as it is formed in California by the courts. In other words, if you incorporated in Delaware because of the business-friendly nature of Delaware laws, those laws would not apply to your corporation in this case as your corporation is considered to be a pseudo foreign corporation. This is, of course, requires more complex analysis.

Further, if you have a business issue arise, you may have to hire a legal counsel for each of the states where there are business transactions, Delaware and California, because there might be multiple jurisdiction issues, thus, multiplying your legal cost.

So before you form that LLC or Corporation, check with an attorney in your state as far as what is best for your business. If you would like to connect with me directly, please visit my website at www.lawgrw.com

About the Author: Gayani R. Weerasinghe is a transactional attorney practicing intellectual property and business/corporate law, including working with entrepreneurs and start-ups on their patents, trademarks, copyrights, protection of trade secrets, and compliance training of employees. Before coming to law, she spent 13 years doing biomedical research, including co-authoring a dozen publications of original research in peer-reviewed scientific journals. She is also a business coach, assisting businesses and professionals in navigating their goals and objectives and setting new ones. For more information, please visit her LinkedIn profile at, https://www.linkedin.com/in/gayaniw or visit her Youtube Channel “Inventive Mind.”