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What to Know About State Tax Nexus and Franchise Fees

Nov 1st 2017
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Whether you are growing your practice into other states or have clients expanding into them, there are several key things you need to know about establishing state tax nexus and franchise fees on corporations. Here, columnist and EA Craig Smalley explains some basics in this area.

First off, there currently are about 16 states that collect a franchise fee on corporations. These include: Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, Missouri, New York, North Carolina, Oklahoma, Pennsylvania, Tennessee, Texas, and West Virginia. But this was not always the case.

I used to love forming corporations in Nevada and I even opened an office there to be a registered agent. But we have since pulled out of Nevada because what made a Nevada corporation special no longer applies. 

For example, when you formed a Nevada corporation you could use something called a nominee director who would be listed on the articles of incorporation, which can be looked up on the Nevada secretary of state’s website, giving the company’s officers privacy. In the state of Nevada, a nominee officer is basically the name of a person who “sits” in the place of the real officers.

You have to disclose the name of every officer in Nevada, such as president, secretary, and treasurer, but you don’t have to list a vice president. On the articles of incorporation in Nevada, you would list the nominee officer for all the offices and then when you create the bylaws of the corporation, you would list the actual officer as vice president. This would protect the identity of the officer because the bylaws are not public information.

There was no state tax on corporations, not to mention it costs double to form a Nevada corporation. All of the good things about forming a Nevada corporation evaporated this year. 

Now, you are no longer allowed to use nominee officers, and while there is no state income tax, if the company makes $3 million or more, it now has to pay a gross receipts tax. 

When nexus laws came into play, you could get out of them because the companies that I formed were simple management companies, which had an address in Nevada, earned income in Nevada, and even if there was an employee in another state, a nexus for income tax wouldn’t be created because no income was being made in the other state.

It was also very popular to create a Nevada corporation for California residents because of the privacy rules. In addition, they would evade the California franchise tax each year because even if you had employees in California but didn’t make your income in that state, the state didn’t collect the $800-a-year franchise tax. 

However, the state of California was losing so much revenue in franchise taxes that it changed the rules. If you have an employee in California – even if you haven’t earned any money there – the state forces you to file as a foreign corporation and pay the franchise fee.

Eventually, the seven other states that collect a franchise fee adopted California’s rules, and other states have adopted similar rules. For instance, if I incorporated in Nevada, earned all of my money in Nevada, and I am in a service business paying an employee, most states make you register as a foreign corporation in their state. I made a killing forming Nevada corporations a few years ago, but with Nevada’s law change, it doesn’t make sense to do so anymore.

Wyoming has favorable rules like Nevada once had, but honestly, with the nexus rules the way they are, there is no reason to form a corporation out of state anymore. That said, it still makes sense for big businesses to form a corporation under Delaware’s laws due to the pro business courts.

In short, Nexus issues are hot right now and what we used to do just doesn’t make sense anymore. 

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