Setting Up an Out of State Corporation by a California Resident
California residents often ask me, “should I set up an out of state corporation to save or avoid taxes?” California residents often mention Nevada because it has no corporate income tax and no personal income tax. Many “business advisors” promote these Nevada LLCs or corporations for this very reason (with the caveat that they are not providing any legal or tax advice to you, of course.) Despite this, often there is no tax advantage to doing so – in fact, setting up a Nevada corporation is often more expensive for California residents and some people look to Wyoming as an alternative. Here, we focus primarily on Nevada.
Setting Up a Nevada LLC or S-Corp
If you set up a Nevada limited liability company (LLC) or Subchapter S corporation (S-Corp), since the profits flow through to the owners, any owner who is a California resident will be taxed on all the profit (and compensation) that he or she receives. With an LLC or S-Corp, you cannot avoid paying income tax by keeping profits in the LLC or S-Corp since these are considered “pass through entities.”
Setting Up a Nevada C-Corp
Even if you set up a Nevada “C” corporation, it also has its own disadvantages. Although the “C” corporation will pay no Nevada income tax, it will pay federal income tax on any profits that the C-Corp receives. Also, if you take any salary or dividends from that corporation and are a California resident, you will pay California income taxes on that money. Now you are even worse off because you’ve just been hit with the “double taxation” issue that California residents attempt to avoid by forming an LLC or Subchapter S corporation. In addition, California will tax an out-of-state entity on income it earns in California.
California Filing Fees For Out of State Entities
Finally, if you have an out-of-state corporation or LLC but have headquarters or any office or “presence” (telephone number, home office, P.O. Box, etc.) in California, you have to register that LLC or corporation as an out-of-state entity with the State of California – and the filing fees and minimum annual tax are the same as if you set up the entity in California. Given the additional costs of setting up an out-of-state entity, frequently going that route is more expensive than simply using a California entity in the first place.
California Residency Test
A California resident pays California tax on all of his or her income, even if that income comes from outside of California.
It is very difficult to establish residency outside of California if you are doing anything in California. Generally, California takes the position that someone is not a California resident only if:
- His/her presence in California does not exceed 6 months within a taxable year; AND
- If he/she maintains a permanent home outside California; AND
- If he/she does not engage in any activity or conduct within the State other than as a seasonal visitor, tourist, or guest.
If you are present in California for more than 9 months in any given tax year, the State presumes that you are a California resident. For details, see the Franchise Tax Board’s Guideline for Determining Resident Status, which can be found at http://www.ftb.ca.gov/forms/misc/1031.pdf.
Does Setting Up an Out of State Corporation by a California Resident Make Sense?
In short, unless you plan on meeting the test to NOT be a California resident, you usually aren’t going to save any money by setting up an out-of-state entity – and it may well cost you more than setting up a corporation or LLC in California. For more information on setting up a LLC, S-Corp or other entity, in state or out of state, contact Anh Tran, an Orange County Estate Planning Attorney at Modern Wealth Law.
John Wong advises on all aspects of estate planning, probate, asset protection and trust administration. He believes that estate planning is about planning for life; while having protections in place should the unexpected occur.
