Should I Set Up My New Business in California or Nevada?

Generally, business owners who own and operate a business in California as a sole proprietorship or general partnership, may be considering establishing a more formal business entity, such as a limited liability company (LLC), corporation, or some other entity.  Such owners initially ask themselves where, i.e. in which state should I create this legal entity?  For many such owners, California is not necessarily on the short list – although as the article explains, it likely should be.

When establishing a new business entity, aside from picking the name, the decision which must be answered first, is which state to create the entity in.  And even the entity name can be driven by this state inquiry because a given business name might be available in one state but not another.  By “create the entity,” we mean in which state will you register the entity with that state’s secretary of state, along with filing the requisite paperwork and filing fees.

Also, as a quick aside – there may be good business reasons for picking a rather generic business name for the legal name of the entity, which then may allow you to use a variety of more creative dba’s (doing business as) for your various product and service offerings.

And why are we even discussing this as a question of state-law?  Because business entities are creatures of state law and as such the laws which govern them are largely dictated by state law.  Any federal law implications will generally not vary across states, e.g. the federal tax brackets for corporations do not depend upon the state of incorporation.  In general, federal law does not concern itself with business entity formation.  The two big areas where federal law generally impacts business entities regardless of industry is in taxation and securities regulations.  Other federal law implications are generally applicable on a case by case basis by industry.  For example, if your entity is a pharmaceutical company, then your entity will need to comply with the Food, Drug, and Cosmetic Act as administered by the FDA.

Turning back to the state inquiry of where you should set-up your legal business entity, you need to know that there can be profound differences from state to state with respect to the different entity types.  For example, in California, LLCs (limited liability companies) are only for general business, i.e. not professionals.  A law practice in California cannot be setup as an LLC; whereas, in New York, a law practice may be an LLC.

Currently, these are the states most often discussed in this context:  California, Delaware, Nevada, and Florida.  For California residents who operate a business in California but are considering setting up the legal business entity in another state, California is the natural default choice.

Delaware is often a candidate largely for historic reasons since a majority of the world’s very large corporations have been and are still incorporated in Delaware.  And because of this history, the Delaware courts are very experienced at hearing business law matters and there is a large body of corporate case law.  Such a large body of case law can provide some certainty with respect to potential litigation, and certainty is always something a business desires.  However, also because of this long history, the corporate laws in Delaware tend to favor large corporate entities over smaller entities and thus Delaware might not be an ideal candidate for a smaller entity.

Nevada and Florida are gaining popularity because these states have no income taxes, thus there may be little financial impediments to registering in Nevada or Florida, even if your physical location is in California, i.e. you will not be subjected to paying income taxes in Nevada or Florida.  Additionally, Nevada and Florida have also gained popularity because these states portray their business laws as friendly and supportive of businesses.

But here is what you must understand.  Regardless of what state your legal business entity is located in, if you operate a California-based business, your business, at a minimum, will be subject to California law with respect to: tort liability, employment law, and California state taxation.  Internal business conflicts between the owners of your business will generally be governed by the law of incorporation/registration as a default and, if the entity is set-up properly, even the state law of incorporation/registration will be supplanted by whatever agreements have been drafted to govern the relationship among owners.  Thus, in the areas where a business might be trying to register in another state other than California to receive the benefit of that state’s more business-friendly laws, it is an objective than cannot be realized with respect to tort liability, employment law, and California state taxation.

Consider scenarios A and B.  In scenario A, the California company registers an LLC in California.  In scenario B, this same California company registers an LLC in Nevada.  Also note, under scenario B, that California law requires that this company also register their Nevada LLC with the California Secretary of State as a foreignly registered business entity, operating in California.  Within these scenarios, there is a second consideration: On an annual basis, what is the tax situation for this California company?  Under scenario A, this company will pay an annual fee to the California Secretary of State for maintaining the LLC’s registry (which may be styled as an LLC tax and may be a flat tax in the $800 to $865 range), in addition to all normal California state taxes, including payroll and income taxes.

Now consider scenario B.  Here this company must pay not only everything that was paid to California under scenario A (because they had to register with the California Secretary of State as a foreign LLC), but also this company will also have some additional costs in Nevada because the business entity was formed there.  True, the company will not owe Nevada for income taxes, but there are other costs to consider.  For example, Nevada currently has an annual filing fee of $125 for LLC’s, and the business may also have to have a State of Nevada Business License at $200 per year.  Plus, there is an additional cost of maintaining a postal address in Nevada for the purpose of service (i.e. being served with various notices and summons).  Such a cost might be an additional $100 or so per year.  Thus, by registering the LLC in Nevada, the company will be paying more per year than had they been registered in California.  And are they gaining any benefits to having registered in Nevada that would justify paying more per year?  This California company would likely not benefit from Nevada’s tort laws, nor Nevada’s employment laws.  At best, only the relationships between the owners might be governed by Nevada law and, even then, only if there was no agreement in place between the owners.

Thus, under most scenarios where the business is located in California it makes sense to file for a particular business entity in California and not another state.

Eric Kelly