R. Shawn McBride recently spoke with Angela Langlotz about the topic of what state people should form their entity in. Here is the transcript:
R. Shawn McBride: A couple of people emailed and followed up with me and said, “Well, how do I know what state I should form my entity in?” This is something that we get. People form LLCs they form corporations. People in the know, know they get to choose, so you’ve got to choose the one that’s right for you. So, we’re going to go a little bit into the elements of that. Angela, where do you start the analysis when you’re working with people or discussing an issue? Where do you even begin the discussion or how do you begin your analysis?
Angela: Well, I ask them, “Where are you going to do business?” That’s kind of a threshold issue. If you’re going to be doing business in California, you’re going to have to register your business. At some point, you’re going to have to register your business in California either as a native corporation or as a foreign corporation. Wherever you do business, if you have a physical location there or you have enough touchpoints, called nexus, you’re going to have to register your business there. So, if you’re in California … And California is really bad about this and it’s expensive to have a corporation there. It’s like $900 a year just to have an LLC in California. It’s ridiculous. So, when people ask me what they should do, my first answer is, “Don’t do business in California.” No, seriously, I tell them, “Don’t do business there. Just, just don’t. Just leave, go someplace where they actually appreciate your efforts.”
R. Shawn McBride: It is a huge economy. I mean the Calexit folks will point out how big the California economy is. Of course, I always make the point they’re getting a lot of their water from other states in the U.S. They’d be in tough shape without the rest of the U.S., but there is a lot of money in California.
Angela: And then there’s that falling off into the ocean during the big one, right?
R. Shawn McBride: Right. So, California … And, I’m with you. Actually, it’s not really a true practice area of mine, but I’ve migrated several companies from California to Texas. The owners get smart. They look at the tax structures. They look at a lot of the issues, and the owners are moving from California to Texas.
R. Shawn McBride: So, that’s something I’ll do from time to time is I’ll migrate companies into Texas, and … California is one of the big source states.
Angela: Oh, yeah. California doesn’t seem to realize that everything is mobile now. Capital mobile … Everything is mobile. So if you want to make it really, really difficult for people to earn a living and grow a business just be like California, and then people will leave.
R. Shawn McBride: Well, they get the success in California. I mean, they’re from California. They work for somebody else in California. They start to build the business. Then, smart business owners start saying, “Well, why am I in California? You know, I can hire a workforce in another state or particularly with the internet,” and the way things are working so much today with remote communication you can communicate with people from everywhere. So, you’re physically in Texas or some other lower taxed state, and you’re communicating with people throughout the entire world, but you don’t have all that burden and regulation and tax.
Angela: Exactly, and when you’re like California you share a very long border with a more tax friendly state, say like Nevada.
R. Shawn McBride: Right.
Angela: Probably not the best idea to continually antagonize your business owners such that they wish to flee your state.
R. Shawn McBride: Yes. I mean, we see this with New York and Florida too. I spent a fair amount of time in Florida and we see a lot of New York people migrating to Florida because they stay in the same time zone. There’s a little more distance than a California to Nevada move, but people say, “Well, okay. Well, I can just move down the street-
Angela: There you go.
R. Shawn McBride: … and you know I’ll still be in same time zone. I can still service my customers, but I don’t have to deal with all of the New York regulations. I can now be in Florida. Maybe you’ll get … depending on what you prefer with the weather … you’re not going to get huge snow storms in Florida.
Angela: Yeah, pretty much. It’s pretty much never going to happen.
R. Shawn McBride: Right, exactly. It’s very, very rare. It’s quite a news event when we get snow here in Florida, which is very rare.
Angela: Yeah. But, you can actually form a corporation anywhere you want and be subject to their laws, and register it as a foreign corporation wherever you want as well. If you have a physical presence or enough nexus in that state that you actually need to register it there.
R. Shawn McBride: Right.
Angela: Wyoming is a very … You know people talk about Nevada corporations … Blah, blah, blah … Wyoming corporations, Delaware corporations …I-
R. Shawn McBride: Right.
Angela: Go ahead.
R. Shawn McBride: Let’s take a quick second and just break it down for the viewers. So, you get to pick the state you form in, and then you’re subject to their laws. There’s something out there called the Internal-Affairs Doctrine, which has been well recognized in the U.S. It basically says whatever state you choose to form in that’s the law that governs your internal affairs. Now, a little bit of challenge happening with that in some states now. We’ve seen Colorado and Maryland start to question whether some of this single member LLC stuff and all can be recognized. But, you basically get to choose where you form your company, and you’re going to be governed by their laws on how you run the internals of your company. So, you get to pick.
R. Shawn McBride: Then, other states will regulate if you’re doing business in their state and you’re sufficiently doing a certain amount of business in their state, then they’re going to say, “Well, you have to register here.” Which basically is their hope to tax you.
R. Shawn McBride: Once you’ve registered your business in a given state then you’re on their tax rolls, and they know to send you a tax form and expect a tax return from you.
Angela: Right, everybody wants their slice of the pie.
R. Shawn McBride: Right, and then bad things happen if you don’t file to do business in a state right. You’d lose your right to bring lawsuits generally. You have potential tax penalties and issues. We had a litigation matter a couple of years ago where the plaintiff had failed to file for standing, so it became an issue. They ended up not bringing the lawsuit because their cost of going back and complying with the tax regulations was more than what the lawsuit was worth.
R. Shawn McBride: You just never know, right? But, you won’t be dotting these Is and crossing these Ts, because … I’ll tell you what … you go to get acquired, or you go to do something significant, or you get into one of these litigation situations, these things can come back and haunt you.
Angela: Oh, sure. Oh, yeah. Yeah.
R. Shawn McBride: You get to pick your state of formation, so you’re going to be looking at why you want to pick a different state. Then, basically any state you operate in you’re going to have to file it. For some people, as we were discussing earlier, the state you form in you may want to just file an operating … It’s just one less set of filing, one less set of compliance.
Angela: Well, I mean, it really depends. Some states have favorable laws when it comes to like valuation discounts. We were talking a couple of weeks ago of getting valuation discounts and how the IRS has in the past few years passed regulations that basically says, “If you have written into your documents restrictions on transfer that are more restrictive than state law for valuation discount purposes, we will not honor that.” Fine, okay. So, clever, nimble states like Wyoming will say things like, “That’s fine. We’re going to create a new state law for people who want to have these closely held family corporations and we’re going to call it Wyoming Close LLC. That’s what we’re going to do. And, so we’re going to go around this rule that says that we can’t basically draw the mustache on the Mona Lisa and devalue our own-
R. Shawn McBride: Right.
Angela: … business interest for tax purposes.” So, Wyoming for example has created the Wyoming Close LLC in order to restrict transfer by statute or some particular business interest. But, that’s the choice of the business owner. So, if you want to form a Wyoming Close LLC, you can do that just by picking the box or inserting some language into the … Oh, goodness. Shawn, help me out. What do you file with the Secretary of State?
R. Shawn McBride: Your charter or your business formation or-
R. Shawn McBride: … articles, and when . . .
Angela: Articles, yeah. Thank you. Articles. Sorry, having a blonde moment here. And, you can do that. You can’t do that in most other states that don’t have those kinds of statutes, and most states don’t. So, that’s an example of picking a state for a particular purpose that suits your end goal.
R. Shawn McBride: Exactly. I think so much of this is tied to, what are your end goals? Where are you going with your business? So, you might be taking a Wyoming Close LLC, because you have these family transfer issues. You might be picking a Delaware LLC or corporation because you have big player investors that are familiar with that statute. And Delaware, like Wyoming … I remember practicing in Delaware. The lawyers would get together and they would send laws to the legislator every year, and it would get on the dock, and it would get signed by the governor because Delaware makes so much of their state revenue off filing fees they make sure the law gets updated.
Angela: Well, and that’s something that the Nevada attorneys and the Wyoming attorneys do as well. So, there’s a whole lot of people who do practice with these held entities, and they want to make sure that they get that piece of the pie. They’re not losing it to other states who have more favorable laws or more flexible laws.
R. Shawn McBride: Right. We see these in the smaller states to become common choices because it’s important to those states to keep that filing business … Delaware, Wyoming, Nevada, they want that business.
Angela: Oh, yeah. They make so much money from it. I mean, Nevada for a while until they got greedy and people started going to Wyoming instead. So, Nevada caught a little bit of California. California got greedy, so everybody started leaving California.
R. Shawn McBride: Yeah.
Angela: Nevada goes greedy. They started charging … You had to buy a business license even though you didn’t do business in Nevada. It was ridiculous, so I just said, “Fine. I’m taking me and all of my clients to Wyoming,” and that’s where everybody is now. So, if you get greedy it’s okay but we’ll take our business elsewhere.
R. Shawn McBride: Exactly, and then big states, California, New York, Florida, even Texas, even the more business-friendly of those states … you’ve got big states with lots of issues and busy legislatures. There’s no guarantee that updating your corporate or LLC statute is going to get through the legislature that the governor processes in even a year.
Angela: Well, yeah. These states have a more diverse revenue pool, so those filing fees to Texas … it’s nothing to Texas, to Nevada or Wyoming it’s a lot.
R. Shawn McBride: Well, Texas wants a job in business, so they have some motivation. But, the filing fees aren’t significant, and there’s a lot of other stuff going on with a state with … whatever it is … 30 billion in population or something … there’s a lot happening … versus Wyoming has less population than Dallas county.
Angela: Yeah. Yeah. It’s crazy when you think about it.
R. Shawn McBride: Yeah. So, you get to pick. You’re going to choose, and you’re looking strategically. Let’s talk about some of those strategic hooks. So, we’ve started to touch on it. Who are your investors? What are you trying to do as far as your control and transfer of your business? What do you want? I mean, if I have fiduciary duty issues I will often pick a state that has flexible fiduciary duty rules so that I can custom tailor those fiduciary duty provisions to the way that my management wants it to be. Whether I want a high standard or a low standard, whatever works I do. Most of the stuff is very specific to your company and what you want to do with your company in your longer term vision.
Angela: Right, exactly.
R. Shawn McBride: Any other factors you think about, Angela, when you’re kind of working through the analysis?
Angela: Not really. Do you have anything to add?
R. Shawn McBride: Well, I think those are it. I mean, I’m not saying there isn’t something specific for another client out there that wouldn’t come up in the analysis.
R. Shawn McBride: But, for most people: Who are your investors? How are you managing this business? Where are you doing business? Do you have something unusual with the contractional relationship with the owners, which would push you to a certain state? Those four or five factors, really, are enough to help you decide what state you locate in. Once you pick the location, you do have that additional compliance factor, which is if you’re doing business in other states you’re going to do these foreign registrations. You’re going to go notify those states you’re doing business there, and basically, put yourself on the tax rolls.
Angela: Yeah. It’s funny though, more and more I see internet businesses. They’re kind of everywhere and nowhere as far as nexus goes. I mean, unless you’ve got like a warehouse somewhere … I mean, in some states even that’s not considered nexus. I mean, it just really depends on what state you’re in what’s considered a business nexus, and having inventory there without other factors is not enough. So-
R. Shawn McBride: Yeah, this nexus analysis is really what determines whether we’re subject to being taxed and then-
Angela: Or even subject to registration that state-
R. Shawn McBride: Or subject to registration.
Angela: … which is my point. So, you can choose. Say you’re in New Mexico, and you start up this great internet based company. You don’t have any employees anywhere. Maybe your employees are all contract labor. Maybe they’re overseas. I mean, there’s so many different ways to get labor now that you don’t have to have a fixed office in a place where everybody goes. Everybody can meet online, which is simultaneously everywhere and nowhere.
R. Shawn McBride: Right.
Angela: So, I’m sure it just drives the states crazy, because they’re all looking at a way to get their tentacles into businesses so they can extract some tax from it. But, a lot of times it’s just not possible. Thank you, internet.
R. Shawn McBride: Right, and that’s reality. The states want the tax. They’re going to try to get it. Now, the Supreme Court has been a little helpful to businesses saying that you have to have sufficient minimum contact. You have to be doing something in that state in order to reasonably to be registered or required to pay tax there. A lot of states are trying as many different avenues as they can to hook people with taxes, some of which may or may not be constitutional. I’ve seen some that look like they go pretty darn far, and maybe if somebody wants to be the test case and fight it they may get around it on constitutional bases. But, most business owners don’t want to spend a lot of time litigation and spending money on that type of stuff.
Angela: And again, California has been a major offender, right?
R. Shawn McBride: Yeah. California wants every tax dollar they can get.
Angela: Well, and they go about it sometimes in extreme measures. They tried to tell this one guy once … this actually did, I think, go to the Supreme Court or at least maybe it went to the Ninth Circuit Court of Appeals. They actually tried to tell a business owner who legitimately moved to Nevada, just across the state line, into I guess Incline Village I think it was … they actually tried to tell him that he could not move.
R. Shawn McBride: Yeah.
Angela: He could not leave California. It’s like the Hotel California. You can check out if you’d like, but you can never leave. You’re still subject to tax forever and ever. The court … and I think it was the Ninth Circuit Court of Appeals … said, “We don’t think so. Knock it off,” and I think they awarded some pretty hefty attorney fees and maybe even some penalties against California. As well they should, because basically, California is using the confiscatory tax power of the state and the California Franchise Tax Board to terrorize and persecute people who have the audacity to start building businesses in California and then leave when they figure out California is not a good deal.
R. Shawn McBride: Right, and we’ve seen similar issues with New York where they try to tax a business and the sale of the business even after the person is no longer a New York resident.
Angela: Yeah. I wonder, how does New York even find out about this? The guy leaves. The guy sells his business. Do they figure, “Oh, he’s not sending us tax anymore. I wonder what happened. Oh, he sold the business? Oh, hey. We want our tax.”
R. Shawn McBride: They track it. Oh, they track it, they definitely do.
Angela: It’s crazy.
R. Shawn McBride: They’re on top. I mean, of course, we’re living in an internet world. It’s not the same situation, but the baseball teams and the football teams show up in particular states for games, and California in particular, they’ll get the roster of all the major league baseball players that pass through California, and they’ll make sure they get their California taxes paid in full.
Angela: Yeah, got to pay the tax.
R. Shawn McBride: Not really the point of it, but you want to try to minimize your nexus with these kinds of states. If you’re sitting there doing business in California, New York, Illinois, or some other ridiculous tax jurisdiction you may want to … and, your business is mobile it’s not tied to people at that state … start thinking about some planning earlier than later, because you don’t want to get a whammy when you sell your business or when you grow your business. Try to minimize that as much as you can for the future.
Angela: Well, yeah. And, make sure you get advice about this too. Do consult an attorney before you … if you’re going to move, make sure that you’re really dotting your Ts and crossing … dotting your is and crossing your Ts. Well, that would have been interesting, huh?
R. Shawn McBride: Yes.
Angela: Plan your exit.
R. Shawn McBride: Right.
Angela: So, if you’re going to Calexit-
R. Shawn McBride: Yes.
Angela: … or NY exit, make sure that before you do that process that you meet with an attorney like Shawn, who does this sort of thing for people and say, “Listen, this is my plan. How can I do this so as not to be caught up in any tax shenanigans from this?”
R. Shawn McBride: Yes, and particularly for your personal reference. You know, there’s a lot of tests about whether you have a connection within a state, whether you’re subject to tax in that state. I was recently working with some other lawyers, and we were doing an analysis with a D.C. resident, who was looking at what their options are. Of course, D.C. you’ve got a lot of options. You’ve got Maryland or Virginia right on either side of it. But, D.C.’s tax statutes are if you keep a residency for 183 days you’re subject to D.C. tax. So, I mean, talk about a whammy. Just keeping a place to live in D.C. subjects you to D.C. tax, so you’ve got to be very-
Angela: As a business or as a resident?
R. Shawn McBride: As a resident, a person.
Angela: But, you see that in almost every state though.
R. Shawn McBride: No, no, no. Most states tie it to a physical presence. If you’re present in the state 183 days and you keep a residence there then you’re going to pay taxes. D.C. if you keep a residence in D.C. for 183 days … You don’t even have to be in D.C., just if you keep a place to live in D.C.
Angela: That does not seem constitutional.
R. Shawn McBride: Well, D.C. is unique. Of course, D.C. is in a very unique situation because it’s not a state it’s a federal enclave with its own unique situation so-
Angela: They’re still bound by the Constitution.
R. Shawn McBride: Notions of the Constitution. Yes.
Angela: Right? I mean, that doesn’t give them a pass. They don’t get a pass. There’s no hall pass.
R. Shawn McBride: Interesting. I haven’t thought about this issue, but if you’re in D.C. and you’re paying D.C.’s tax you’re not paying state tax you’re essentially paying an additional surcharge to the federal government. I’m not sure what the constitutionality of it is, but I would love for somebody to comment on it and let us know.
Angela: Well look, when you’re talking about nexus and physical presence it seems like that is probably aimed at maybe congress people who have residences right? They’ve probably exempted themselves from that.
R. Shawn McBride: No, there’s an exemption for congress people.
Angela: Of course there is.
R. Shawn McBride: They pay taxes in their home state. There’s an exemption for congress people. Let’s not worry them, because-
Angela: Right. Well, if though … let’s say that you are a person who is unfortunate enough to actually own a residence, maybe you use it … I don’t know … a few times a year. You’re not there for more than half the year. You actually have a residence and a domicile elsewhere. Maybe you live in New York. Your specialty is bribing congressmen through your lobbying business, and so you want to maintain a residence in Washington, D.C. That is not … just maintaining a piece of property there without your actual presence that does not seem to be a constitutional basis on which to tax somebody, hall pass aside.
R. Shawn McBride: Well, welcome to D.C. You can take a look at their statute and maybe someday some unfortunate client will have to pay that tax, and they’ll fight the process, and we’ll see what happens with it, but unfortunately … yeah, that’s very interesting. As we got into that analysis the other lawyers brought it up and somebody looked at that statute. It’s a very unusual statute, and it may only be D.C. because D.C. is in that very unique situation of essentially being an additional surcharge by the Federal Government versus a state tax.
Angela: They can call it whatever they want. It’s a tax additional surcharge.
R. Shawn McBride: Yes, tax.
Angela: Yeah, let’s see, what else could we call it? Additional surcharge, yeah. I like that.
R. Shawn McBride: If you’re living in D.C., you’re essentially being taxed by the Federal Government at a second layer rather than paying a state income tax, because it’s not technically a state.
Angela: That’s crazy. Okay. Well, whatever. I mean, usually … I’m not arguing their ability to tax. I’m arguing about the basis upon which they’re doing so.
R. Shawn McBride: Oh, I know and may be overreaching, but it leaves a lot of issues out there, and that’s the point. If you’re doing this or you’re going to think about moving your company, which that’s kind of a secondary idea … the first question is where do you locate your business. Then, secondarily as your business evolves maybe you want to move your business. You want to look very carefully at some of these tangential issues to make sure you hit them and that you don’t get a surprise later. Understand your risks. If you happen to be in D.C. and you had that residence in D.C., really sit down with somebody and work through the issue, and understand what your risk profile is. If you’re getting out of New York or California make sure you do it in a way that you’re not going to have a surprise later where they come back asking for your money, because they do chase the residents out of state, particularly the successful ones that make a lot of money.
Angela: Oh, yeah. They’ll just hunt you down and relentlessly badger you.
R. Shawn McBride: Yes, exactly. Because its money and they want it, and they particularly get angry when people leave their state and destroy their tax money.
Angela: Well, I would argue they’re destroying their own states through their tax policies. They’ve only themselves to blame for people calexiting or whatever you want to call it.
R. Shawn McBride: When you make it more attractive for people to go somewhere else . . .
Angela: Absolutely. Absolutely. Why do you think corporations are leaving California in droves? You know Shawn, you and I both practice law. You’re licensed in Texas. I’m licensed in some other states that are very heavily tax advantaged. Toyota is coming to Texas from Florida. Why do you think that’s happening?
R. Shawn McBride: From California.
Angela: From California, sorry. Yeah, California. California hasn’t gotten it quite figured out yet. Instead of saying, “Hm, how can we change our laws to be more friendly to business,” they go, “Hm, how can we penalize businesses for leaving.” So, you throw up your hands and you go, “You people are so stupid. You just don’t get it do you?”
R. Shawn McBride: So, folks we hope we gave you some good pointers for how to pick which state to locate in. If you have other questions feel free to email and follow up with me or Angela. We can get you some more contact in the future. Angela does this kind of tangential to her IP practice, which is where she spends most of her time, really helping people build that portfolio of assets. Let me tell people just a quick note about that for anybody who might watch this video later, so they kind of know what you do.
Angela: Yeah. So, I help business leaders protect, and form, and defend their intellectual property and you can find me online at www.trademarkdoctor.net.
R. Shawn McBride: There you go. And, I’m R. Shawn McBride, helping successful private business owners build companies that stand the test of time. Making sure that wealth is really protected for you and your future. That’s my goal, my mission whether it’s a speaker, consulting, or practicing law. That’s what we really want to do, and it starts with things like this forming in the right state, moving to another state if necessary, doing those things to really make what you’re doing so much more valuable, and to get to your goals and dreams. So, if I can help you let me know www.McBrideforBusiness.com. Let us know if you have future ideas for videos and we’ll see you again soon. Talk to you soon.
This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity. Each case is unique. Past results do not guarantee future outcomes. Freeimages.com/photographer creative daw.
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