When you decide to form an LLC or corporation, you must first register your business in your home state (also referred to as your domestic state). But if you do business in several states, you may need to foreign qualify to do business in those states as well. That’s when things get a little more complicated.
Let’s look at the differences between a domestic and foreign qualified LLC or corporation and what this means for your business.
Domestic business formation vs. foreign qualification
A domestic LLC or corporation is a business that is formed within its home (domestic) state.
Foreign qualification is when a legal entity conducts business in a state or jurisdiction other than the one in which it was originally formed. (It is not to be confused with being a business in a foreign country.)
For example, if you initially form an LLC in Maryland, it is “domestic” in Maryland. In any other state in which you do business, you would be establishing a “foreign LLC”. To register to do business outside of your domestic state, you would complete a process called foreign qualification.
What is foreign qualification?
Foreign qualification refers to the process of registering your business so that it can do business in a state other than the one in which you initially formed or incorporated your business.
If your LLC or corporation often conducts business activities in a state in which it was not formed and those activities constitute “doing” or “transacting” business, then your business must “foreign qualify” to do business there. (More on this in a minute.)
This process involves filing a Certificate of Authority with that state. Some states will also require a Certificate of Good Standing from the state where your business is formed or incorporated. There is a filing fee to foreign qualify that varies by state and business structure.
For more information on whether your business must foreign qualify, read: When do I need to register my business in another state?
For more information on foreign qualification, read: Doing business in another state (foreign qualification).
What does it mean to “do business”?
Unfortunately, there is no easy answer to that question. Few state statutes or legislative laws define the term. Instead, they mostly include a list of activities that do not constitute doing business — such as having a bank account or doing business in interstate commerce.
It is the courts that mainly deal with the issue of what constitutes doing business. They look at many factors to determine whether the business was localized to the extent that qualification was necessary.
These include the following:
- Does your company have a physical presence (like a factory or stores) in the state?
- Does your company have employees in the state?
- Does your company accept orders in the state, or have liability to collect sales tax?
Be aware that this is not a complete list, and the state statutes and the courts have different criteria for what constitutes doing business. To determine whether your business needs to foreign qualify in a particular state, it is best to get the advice of an attorney.
To the IRS, “foreign” means something else
Don’t confuse the terms domestic or foreign with the IRS’ definition of the terms. For tax purposes, the IRS designates a business as “domestic” or “foreign”. In the eyes of the federal government’s revenue service, a domestic business is a company that is organized in the US under US laws.
For example, the LLC formed in Maryland would be considered a domestic business by the IRS. If that LLC also decides to qualify in any other US state, the business would still be considered a domestic one.
Any business formed or organized outside the US or its laws is considered by the IRS to be a foreign business.
Where should I incorporate my business?
When you decide whether to incorporate your business as an LLC or corporation, you should also consider where you will form your business.
Incorporating in your home state makes sense for most small businesses that don’t anticipate operating in multiple states or only have a small number of owners. This can also reduce the cost, complexity, and administrative duties that are present when multiple states are involved.
However, you do have the option of forming your LLC or corporation in a state other than your home state. This typically happens when a business owner wants to take advantage of business-friendly rules and favorable legal precedents in a state. This is particularly true if your business will operate in multiple states and has many owners who are in various states. (Delaware and Nevada are two popular formation states for these reasons.)
Choosing a formation state
Some of the factors to consider when choosing a state to form your business include the following:
- Any fees and filings that are required. These may include the initial filings, annual reports, and other required information reports, such as a change of Registered Agent.
- The degree to which assets are protected. This is particularly important with an LLC because the states vary more widely with an LLC than with a corporation.
- Management flexibility and simplicity. Some states impose more requirements than others do.
- Tax obligations (such as franchise taxes) and, conversely, any tax incentives.
Considering Delaware and Nevada?
Delaware and Nevada are two popular states for formation and incorporation.
A large percentage of Fortune 500 companies are incorporated in Delaware. Some of the advantages include a court system that specializes in corporate cases, no personal income tax for non-residents, and flexibility for structuring your corporation.
To attract business owners to its state, Nevada is replicating Delaware’s model. Businesses who incorporate there are not subject to state corporate income tax and there are no fees on corporate shares. The state also waives personal income tax and franchise tax for corporations and LLCs. And, as in Delaware, shareholders, directors, and officers of the LLC don’t need to be Nevada residents.
Whatever you decide, if you incorporate or form your business in one state but do business in another state or states, you must foreign qualify in those states.
For more information, check out: Selecting the best state to incorporate or form an LLC.
Learn more about BizFilings’ Foreign Qualification Services.