There are steps you can take as a business owner to limit your exposure and protect your personal assets. This article explains how to legally separate you and your business, thus protecting yourself from the risks of business ownership. By having an entity (corporation or LLC), there is a legal presumption that you are not liable for corporate debts.
If you start a business without forming an entity, then your legal status is “Sole Proprietor.” There is no legal separation between you and your business. The debts and obligations of your business are your personal debts and obligations.
If you do not create an entity but use a business name that is different from your legal name, you need to register a Fictitious Business Name (another article topic altogether). While you are legally required to do this as a sole proprietor, having a registered FBN does not create a separate legal entity, and you remain personally liable for the operations of your business.
Separate Legal Existence
When you create a corporation or LLC that entity has a legal existence that is separate from you personally. The entity is “born” as of the date the Articles of Incorporation (for corporations) or the Articles of Organization (for LLCs) are filed with the Secretary of State.
The general rule is that shareholders, officers and directors of corporations, and members and managers of LLCs, are not liable for the debts or obligations of the company. This is known as the Corporate Shield Doctrine; also known as “limited liability.”
In your contractual dealings with anyone, such as a client, vendor, supplier, contractor, etc., you would clearly designate the full name of your business entity (not your personal name) as the party/signatory to the contract. If you execute the contract on behalf of the entity and not yourself personally, the entity is the proper party to the lawsuit in the event of a dispute. If an adverse judgment is entered, it is against your entity, not you. Your personal assets are protected. If the entity needs to file bankruptcy, your personal credit is left intact (assuming you haven’t personally guaranteed any obligations).
Exceptions to the Rule
As with any general rule, exceptions exist to the Corporate Shield Doctrine. If you fail to pay your employees or commit other Labor Code violations, then you can be personally liable. If you engage in acts outside the scope of your corporate duties, or if you commit fraud, you cannot hide behind your corporation. If you personally guarantee a contract or sign in your personal capacity, then your corporation provides no protection. The most heavily litigated exception is the Alter Ego Doctrine, which is so detailed that it requires a separate article itself. To grossly oversimplify the doctrine, you need to run your company like an actual company; adhere to corporate formalities and maintain separate finances. I’ll dive deeper into that another time.
By creating a corporation or LLC for your business you create a legal separation between you and your company, and the legal presumption is that you are not liable for the obligations of your company. If you are in business, whether you are selling products or performing services, I strongly urge you to consider creating a legal entity to limit your liability and protect your assets.
This is the story of my battle with a copyright troll. The creature emerged from cyberspace, threatening my client with litigation and demanding an extortionate payout. I battled this troll and sent it back to the cave from which it came.
This image is a clay sculpture created by my 10-year old daughter. I figured this is a good representation of a physical manifestation of a copyright troll. I took this photo myself and my daughter gave me a "license" to use her sculpture. Using your own content online is the only way to guarantee you won't be attacked by a copyright troll.
What is a Copyright Troll?
A “copyright troll” is someone who makes a living by litigating against people and businesses who unwittingly or carelessly share copyrighted content online. Copyright law exists to encourage and incentivize the publication of creative works. Copyright trolls abuse the system by extorting money from business owners who lack the resources to defend themselves in court.
Please don’t read this article as me being unsupportive of creatives enforcing their rights. I’ve represented copyright plaintiffs against infringers in court. If you created copyrighted content and someone infringed on that copyright, then you should be compensated. If you create content and copyright that content, then you absolutely should have the right to create income or make a living from your content. Today I’m talking about people who don’t create revenue from using their own content, but rather from extorting settlements from people who unwittingly use the content.
The Troll Emerges
Last year a client forwarded an email to me that had her a bit frightened. The email was from a copyright mill demanding $1,700 in damages because my client’s blog allegedly contained an image that belonged to someone else. The email contained a link with detailed information about the claim.
The link went to a page that had enough information that one might feel tempted to pull out the checkbook. They showed us a screen shot of my client’s blog post – from twelve years ago – containing an image that was apparently found online. The link also showed an assignment of rights, purportedly from the owner of the image, giving this troll the power to enforce the owner’s rights against infringers. Presumably the owner and the troll had a profit-sharing agreement. Frankly, the entire operation was impressive and intimidating. I see why someone might be tempted to pay a couple thousand bucks to make the problem disappear. That certainly costs less than defending a lawsuit.
A quick word about reproducing images found online. For example, if you write a blog post and want to include images to bring life to the post and encourage engagement and clicks, you need to be very careful before posting content found online. If you reproduce unlicensed content that is owned by a third party, especially a litigious one, you can expose yourself to an expensive and totally avoidable problem. Always ensure you have a license to reproduce any content online. This includes text, images, video, artwork, or sound. The only failsafe way to ensure you don’t get sued is to only post content you created yourself or for which you have written permission (called a “license”). The photo at the top of the article is an example of this failsafe method - I took the photo myself. While I did not create the sculpture, my daughter, the creator, gave me a license to use it for this article. (Thanks Julia!)
I should also mention how damages are calculated in copyright cases. There are two measures of damages: the infringer’s profits gained from the infringement; or the owner’s lost income.
Now a word about litigation. The troll was threatening to sue my client and was demanding money (17 hundred-dollar bills) to “amicably” resolve the dispute (the troll kept using this annoying word - there was nothing "amicable" about this experience). Copyright infringement claims are within the exclusive jurisdiction of the federal court system. Copyright claims can only be litigated in federal court. Litigation is very expensive. The filing fee just to initiate the lawsuit is $400. It takes tens or hundreds of thousands of dollars in attorney and expert fees to move a case through the docket to trial. Regardless of how this copyright troll might structure a fee agreement with counsel, it would be grossly inefficient to commence a lawsuit on a claim belonging in small claims court (under $10k in California).
I knew a couple things about the $1,700 settlement demand: (1) it was unsubstantiated; and (2) it was a bluff.
Back to the Troll Story
My client delegated blog content creation to a contractor. The client probably wasn’t keeping a close eye on the blog, as she was focused on practicing her profession. About twelve years ago this independent writer may have carelessly used an image she found online. I have no idea how or where the image was found, but the image ended up on my client’s 12-year old blog post.
I knew this troll had no damages. It is impossible to trace profits to a single image on a 12-year old blog post. The photographer who owned the image was in a different field than my client, and there was no chance this person lost income because of the image being used on a blog post.
I figured this copyright mill has hundreds, if not thousands, of similarly extortionate demands in process. They’re looking to make a quick buck and get out. They aren’t looking to actually litigate a case, nor do they want to argue with defense attorneys. Every minute they spend arguing with me, they could be extorting someone else who doesn't have counsel. Moreover, the demand was written by a “case manager,” not a lawyer. No law firm was putting its name behind this shakedown.
Another factor was personal jurisdiction. The troll was in one state, and my client was in another. My client was a licensed professional who worked in her home state, and had no presence in the troll’s state, or the state of the purported owner of the image. Unless you can prove contacts with a foreign state sufficient to establish jurisdiction, and personally serve the party with the complaint in the foreign state, you have to sue the defendant in his or her home state. If you’re in North Carolina and seek to sue a California resident, you likely must sue (and serve) the person in California. I was banking that this troll did not have the resources to sue my client out of state.
I was dealing with a copyright mill, not a law firm. The mill would have to send the matter to outside counsel for litigation. The mill itself could not file suit.
Because this person had no damages, litigation was prohibitively expensive, and I wasn’t even dealing with a lawyer, I knew a couple things about the $1,700 settlement demand: (1) it was unsubstantiated; and (2) it was a bluff. I reached these conclusions before sending the first email.
I introduced myself to the troll via email and said I was counsel for the alleged infringer. I requested information to substantiate the claim, and the case manager happily complied. They showed the image in question on my client’s blog and the alleged assignment of rights, then repeated the $1,700 demand, coupled with a litigation threat.
Every time we corresponded I requested a copy of the owner's copyright registration for the image in dispute. Every time I requested the registration, the request was ignored. Whenever you publish new content a “common law” copyright is established at the time of creation. However, if you want to sue in federal court and have statutory remedies at your disposal, you must have an actual copyright registration, and the registration must be attached as an exhibit to the complaint. The lawsuit is subject to dismissal without an actual registration. To get a registration you must pay a fee and submit an application to the U.S. Copyright Office.
I asked the troll for a copy of the registration. Given that they mentioned litigation in every communication, they certainly were ready to sue and they had the registration in their file, right? Each time I requested the registration the case manager replied that they were under no obligation to show it to me. They were correct. Outside of court, during informal negotiations, they had no duty to show me anything. However, if they wanted me advise my client to pay anything, they had to demonstrate to me they were serious and ready to sue. I knew they weren’t getting inside a federal courthouse without the registration, so I hammered them on this missing document. “If you don’t have a copyright registration for the image, then you cannot maintain a lawsuit! Stop threatening litigation you know you cannot file!”
We played this game through a series of emails. The troll would knock its club on my door, threatening litigation unless we “amicably” paid them $1,700, I would ask to see their registration, they said they didn’t have to show it, and I called their bluff. Rinse and repeat.
I decided I was done playing with the troll after we repeated the process a few times. I knew they weren’t going to sue, and the emails were becoming tiresome and repetitive. I told the troll she was not a lawyer, yet she was arguing the nuances of copyright law while demanding money on behalf of a third party. Negotiating a legal dispute on behalf of a third party, demanding money in exchange for a release, is the unauthorized practice of law. Practicing law without a license is illegal. This isn’t even a grey area. I would no longer engage with a non-lawyer who is breaking the law. If they had a lawyer, who was willing to share a copyright registration with me, then we could have a conversation. Otherwise, I said I was no longer wasting my time and would cease engaging with this person.
I never heard from the troll again, my client did not get sued, and the shakedown ended. The troll moved on to another victim.
Troll Proof Your Website
Please review your website, including your blog, and ensure you don’t publish any content that isn’t owned by you or isn’t licensed to you. You don’t want to invite a copyright troll inside, and you certainly don’t want to attract a troll who isn’t bluffing about filing suit. If you do receive a demand from a copyright troll, or anyone demanding damages for copyright infringement, immediately contact a lawyer and do not engage on your own. Do not try this at home!
You know your business better than anyone else. You negotiated the particulars of an upcoming deal, and you know the numbers and the people. You developed a positive working relationship with the other party and are optimistic this venture will be mutually profitable. You don’t hire an attorney because you fear signaling distrust to the other party and scaring them off, plus you want to reduce overhead. You therefore summarize the deal points in a document you drafted yourself, both sides sign, and you get to work.
A few months later you are frustrated that the other party isn’t holding up their end of the bargain, is underperforming, not communicating, or not making promised payments. Perhaps the other party is saying these things about you. Goodwill between the parties is replaced with bad blood. Now you find yourself in a lawsuit, where this DIY contract is the most important piece of evidence, and it has gaping holes and ambiguities.
This totally avoidable scenario happens all the time. If you had only consulted with an attorney before signing, you would likely be in a stronger position in the lawsuit, or perhaps it could have been avoided altogether.
Worst Case Scenario
This is a case I recently defended. A manufacturer spent years building his brand and growing his business, and he wanted to expand into a new territory by contracting with a distributor. The parties negotiated deal points and memorialized them into a term sheet.
The term sheet provided performance benchmarks and a one-time distributor fee, and the owner had broad termination rights, but the agreement said little else. The owner terminated the distributorship a few months into the deal, but he had been paid a multi-year distributor fee up front. The term sheet said nothing about a prorated refund of the distributor fee in the event of early termination. The distributor wanted his money back, but the owner refused, claiming he canceled within his rights. This created a contractual ambiguity and one party lost money. Cue the lawsuit. Now the parties must testify about their interpretations of the contract terms, and the judge must weigh the evidence to sort through the mess. These cases aren’t cheap to defend.
Rather than getting an attorney review before the distributorship began, the owner did not hire me until after getting served with a summons and complaint. Instead of paying about $1,500 to have counsel review (and rewrite) the contract, he paid tens of thousands of dollars in defense fees and settlement payments. This killed his cash flow and growth trajectory, and the business was shuttered.
The distributor’s hands weren’t clean and the case was potentially defensible, but the term sheet did not contain an attorney fee clause. This means the owner could not recoup his defense fees even if he won the case.
Do I just Hate Term Sheets?
Please don’t read this article as me hating on non-lawyers writing agreement terms. By all means, memorialize the terms of your agreements in writing. You can call it a Term Sheet, Letter of Intent, or Memorandum of Understanding, but the enforceability of the document depends on the wording and circumstances.
In fact, when clients engage me to draft contracts, the first thing I ask is, “What are the deal points?” I can negotiate deal points myself, but business owners often have this part locked down before they come to me. I then merge the deal points into a formal agreement. Ideally, the draft would then go to the other party, where it would be reviewed by their counsel.
Consider the Optics
When you tender a contract draft to a sophisticated party, and it was not drafted by an attorney, it shows. Believe me, I can tell. If you submit a sloppy and unprofessional contract, with typos and ambiguous language, it reflects poorly on you. It makes you appear unsophisticated, inexperienced and cheap. In contrast, if you tell your negotiating counterpart that you will submit the contract draft once your attorney has completed his/her review, the other party will be more inclined to respect you and honor the contract terms. In fact, I recommend letting the other side know the contract was vetted by counsel. You will have better leverage and the other side will be less likely to play games.
What About Contract Templates?
Couldn’t you just find a contract template online, or copy the terms of a contract a colleague or competitor uses? It’s a reasonable place to start. In fact, I usually employ some form of template when I draft any contract. I almost never write a contract beginning with a blank word processor screen.
Having said that, even with a template you would still find yourself preparing your own contract, with all the resulting risk. The template you’re using may or may not be in your favor, and you might not even understand it. If the template is junk, any derivative contract will also be junk.
I once revised a contract for a wedding coordinator. The terms were all over the place and self-contradictory. The client got the template from a colleague, and she just put her name on it. She had been using a junk template for years, so I threw it out and started over.
If you are going to use a template from a colleague or competitor, at least ensure the contract was originally written by an attorney.
In closing, you are free to write your own contract, and you can (and should) use a template. However, you do not know what you do not know, and a desire to cut corners and costs could cost you much more in the long run. Hire a lawyer for your contract needs. Once you have a standard contract in place, drafted by counsel, you could then modify as needed for future use.
Have you ever referred to your business as an LLC, before getting around to forming the entity? Rational reasons could exist – maybe you intend to form the entity after making a few sales, but you wanted to lock down the domain first; or perhaps you believe including “, LLC” in your name makes you appear more established and professional. Either way, if you hold yourself out in business as being a limited liability company (or corporation), when you are in fact a sole proprietor, there can be devastating real-world consequences.
It is very simple to confirm the status of any corporation or LLC in California. Click here to check the status of any registered business in the state. Assuming you entered the name correctly, if someone is holding themselves out as being a corporate entity in California, and they do not appear on the Secretary of State database, then this person has a big problem. If you are contemplating doing business with any company, I strongly recommend looking them up before getting too involved.
Below are examples of faux LLCs I’ve encountered. Litigation battle stories incoming!
Non-existent llc on a purchase agreement
When I was a new lawyer fresh out of law school a client hired me to file suit on a failed real estate transaction in which he was the buyer. The buyer executed a purchase agreement in the name of his LLC, but the seller refused to perform. I drafted a complaint seeking a remedy called specific performance and attached the contract as an exhibit. I confirmed on the Secretary of State website that the LLC existed before filing suit.
The defense immediately served discovery asking the buyer to admit the LLC did not exist at the time of contracting, and that the contract contained a non-entity. This tipped me off that we had a major problem, and I looked up the entity again, this time comparing the date of the entity formation with the date on the contract.
Sure enough, the buyer created the entity months after the contract was formed, just before we filed suit. At the time the contract was formed, the buyer did not exist; it was a non-entity. You might think the member/owner of the LLC could just sue in its stead, but the contract contained a fictitious name, meaning the name was something other than the legal name of the buyer. The fictitious name was not registered with the county recorder, and contracts with non-registered fictitious names are voidable by the other party. The seller opted to void the contract. Had the seller communicated his intention we may have avoided litigation altogether, but that is a separate article.
I realized the case had no merit and we had to cut our losses and dismiss. I learned to always and immediately confirm the legal status of any company within whom I deal, whether it’s my client or the other side. This lesson stuck with me throughout my career.
You should never execute a contract on behalf of a non-existent entity because you’ll lack standing to sue if you should ever become a plaintiff.
non-existent llc on a lease
The next scenario is the converse of the first. Now I represented the defendants. The case involved a commercial lease where the tenant executed the lease as an LLC, and the parties went to litigation.
The complaint named both the LLC and the individual members as defendants. My first instinct was to complain that the landlord improperly sued the individuals, as members of an LLC are generally not liable for company debts. However, I recalled the lesson from the early real estate case, so I checked my client’s status on the Secretary of State website.
I learned my client signed a commercial lease on behalf of a non-entity. The principals of the company erroneously thought they had formed the LLC. They claim to have paid a lawyer to file papers with the state to create the entity, but somehow it never happened.
I wanted to assert that the individual members were subject to dismissal, but they were in fact personally liable for the company’s debts because there was no company! I had plenty of substantive grounds to defend the case, but their personal assets were exposed because they contracted in the name of a non-entity.
Even worse, the owners were operating under a fictitious name, which was not registered with the county. This means if a client refused to pay them for their work, they would have been barred as a matter of law from being a plaintiff!
The landlord dismissed the case after I served discovery that went to the heart of the dispute, so my clients dodged a bullet.
I represented a client, an actual LLC, who was being sued on a bogus fraudulent transfer case. The plaintiff corporation contended a third party owed it money, and that the third party conspired with my client to frustrate collection, fraudulently transferring assets to my client.
The allegations were meritless, but I immediately looked up the plaintiff corporation on the Secretary of State website. The plaintiff entity was never formed. The lawsuit alleged the plaintiff got a judgment in another case, and he was seeking to hold my client liable for the judgment. Nobody in the prior case noticed the plaintiff was a non-entity, and that the judgment was invalid! Compounding the problem, the plaintiff lacked standing to sue in the second case.
I had to bring a motion to change venue before asserting the standing defense, and the motion was granted. Before the case was transferred I notified counsel, as a professional courtesy and in an effort to save my client on defense fees, of my intention to bring a motion to dismiss on the standing issue. Counsel realized his blunder and could not deny his client was a non-entity. He therefore responded that his client was just a fictitious business name (even though the complaint alleged it was a corporation), and that the “true” plaintiff was an individual named Jose.
Counsel presented a fictitious business name certificate to me, but FBN certificates expire after five years. I notified counsel of this defect, and he quietly dismissed the case. I was in his shoes when I was a new lawyer, so I can’t be too judgmental, but this guy had been practicing law much longer than me.
fake llcs on social media
I have seen several people promoting business pages on Facebook with names ending with “LLC”. Curiosity sometimes causes me to casually look them up, and on multiple occasions I have found these “LLCs” to not exist at all. As I said at the beginning of the article, rational reasons could exist but my perspective is these people are holding themselves out as something they are not.
Be very cautious about transacting business with someone willing to cut corners and be disingenuous. I personally believe these people know better, but they lack the resources or know-how to form their own entity, so they take the shortcut and slap "LLC" or "Inc." at the end of their name, hoping nobody notices. These are not the traits of someone with whom I would transact business.
But Tom, what if they just formed the entity outside California? Great question! I have written in the past about the wisdom of forming out of state entities (click here), but here’s the real problem: if you are doing business in California and formed a foreign entity (meaning out of state), you still have to register the entity in California. You have to file papers and pay fees, just like any other California entity.
In closing, if you are contemplating a business transaction with someone holding themselves out as an LLC or corporation, take a moment to check their legal status. Use this link right here. Send me a note if you'd like me to check it for you (no charge!), and let me know if you have any questions.
You've selected a creative and distinctive name for your business and you're excited about your new logo. You want to protect your brand from competitors who take shortcuts and cause consumer confusion by pretending to be you, so you wisely decide to apply for trademark protection. The question becomes whether you should trademark your name (the text), or the logo (artwork).
I usually advise my clients to trademark the name, not the logo. I'll explain why.
There are two kids of trademarks: 1) standard character marks, consisting of text only; and 2) stylized marks, consisting of artwork.
Suppose your business name is represented in logo form, you really love the artwork, and you don't want anyone else to use it. You apply for a stylized mark, spend the money and go through the application process, waiting approximately nine months until the registration is issued, then you are the registered owner of the mark. Congrats!
You later grow tired of the mark and decide to revise. Maybe play with a new font, size, or color scheme, or perhaps a total rebrand to something fresh. I recently had a new logo made for my law practice. Trademarks do not carry over to new logos. You would have no trademark protection for the new artwork, and would have to apply all over again. You would be chained to the original logo design and would be de-incentivized to rebrand.
You learn a competitor is using a name very similar to your own. They might be using the name as a standard character or it might be incorporated into artwork, but you are justifiably upset and want to act to protect your rights. Your attorney advises you that your mark is only for the artwork itself, and if the text is represented in a different form by a competitor, you do not have federal trademark protection. (You might have common law trademark rights in your state, but this lacks statutory remedies.)
In summary, unless a competitor is copying the exact or very similar logo, your stylized mark offers little protection.
Your business name is incorporated into a logo, which you love. You apply for a standard character mark, consisting of the text only, and do not seek trademark protection for the artwork.
Once the registration is issued, you have trademark protection however you choose to publish the trademark, whether it's basic text of any font or size, or embedded in any kind of artwork. By opting for a standard character mark, instead of a stylized mark, the scope of protection for your mark is much broader. If a competitor knocks off your name in any format, you're on much stronger legal footing than if you merely had a stylized mark.
My other business, Eternal Roots, has a standard character mark. The name is embedded in a couple different logo variations, but I didn't bother trademarking the logos themselves. As long as the registered text is in the artwork, then you're protected. I'm now exploring new logo options, and whatever happens to the logo over time, the core brand - the name itself - will always be protected by trademark.
when are stylized marks necessary?
I'm not bashing stylized marks in general. I have multiple applications pending at the USPTO for clients with stylized marks. There are situations where stylized marks are appropriate.
If your brand has distinctive artwork that is not dependent upon standard characters, like the Nike swoosh, and you have built significant brand recognition, then a stylized mark is appropriate.
If you are concerned with bad actors knocking off your brand and selling counterfeit goods, then you definitely want to lock down the artwork.
One of the applications I have pending consists of my client's initials in logo format. We are not concerned about a competitor trying to steal her personal name, but by having the registration, being able to put that ® next to the logo, she's showing the world she takes her brand seriously and is an established businesswoman.
In closing, standard character marks offer the broadest possible protection and enable you to modify your artwork at will. I generally counsel my clients to register their marks as standard character. However, there are circumstances where a stylized mark is appropriate.
Real scenario: a business owner called me to inquire about registering his Nevada LLC to conduct business in California. He lived and operated in California, yet he formed the LLC in Nevada because that state does not have income tax. He formed the entity using an online service - not an attorney - and had no idea what to do next. He didn't have legal advice when he created the entity, he just paid an online service to create the entity.
I inhaled deeply and hoped he wouldn't shoot the messenger. I informed him of the procedure and cost for registering his Nevada LLC in California, which he is required to do, and considering the cost of maintaining one entity in two states, he could form a new entity in California for less. Given the cost and extra paperwork, it made no financial sense to operate his Nevada LLC in California. He still has to pay state income tax to California, and he only created more work and expense for himself.
I gave him a quote with the option of: 1) forming a new California LLC; or 2) registering his Nevada LLC in California. I advised him that the legal cost of each option was roughly the same, but the ongoing/future cost of the second option was twice as high. The prospective client said he would "figure it out," and he never called back. The poor guy wasted money and made his business structure unnecessarily complicated. Sometimes my job requires me to tell people what they don't want to hear.
If you are operating your business in California and considering incorporating in one of the seven states that do not have income tax (Texas, Florida, Nevada, Alaska, Washington, South Dakota, or Wyoming), it can be tempting to form your company out of state then operate in California. By forming your business entity in a non-income tax state, you don't have to pay state income tax, even if you live in California, right? Not only is this assumption wrong, but forming the entity out of state, then operating in California will double your expenses and paperwork.
entity formation in general
Creating a legal entity is relatively simple. You complete a form and pay a fee to the secretary of state of your chosen state, then file the annual statement (called a Statement of Information in California). You have to do more than that to properly maintain the entity (a separate topic for a future article), but that is literally all you have to do to create a legal entity that has a separate legal existence from you personally.
You must designate a person or company in the state of incorporation as your agent for service of process. This is the only person authorized to accept service of legal process, such as a summons or subpoena.
Every year you must file an annual statement, called a Statement of Information in California, and pay a $25 fee (due bi-annually for LLCs). California's Franchise Tax Board also charges $800 a year for the privilege of operating a business entity in California - regardless of whether the entity was formed outside California. You will get a penalty and interest hit if you pay the fee late, and the state will suspend your business if you fail to pay at all.
This process is generally the same across the states, subject to variations in nomenclature.
registering a foreign entity
Suppose you live and work in California, but have already created an entity in another state. Regardless of whether you have a foreign LLC or corporation, you need to register the entity in California before it can do business here. If you are transacting "intrastate business" in California (a fluid and undefined term), then you must register with the California Secretary of State before transacting business. It's a safe bet to assume that if you are an LLC or S-Corporation, and you live and work in California, but formed a Nevada LLC, you need to register the LLC in California.
Here's what to do. You must submit a form and pay a fee to the Secretary of State of your state of incorporation, and request what is generally called a Certificate of Good Standing. Again, nomenclature varies among the states.
Once the Certificate of Good Standing arrives, you file an Application to Register a Foreign LLC with the California Secretary of State, along with a $70 filing fee. Upon approval, you have to file and pay for the annual Statement of Information (due within 90 days), and you must pay the annual $800 FTB tax.
These annual fees are in addition to the fees you must pay to the state of incorporation. You also must appoint an agent for service of process in California, in addition to an agent in the state of incorporation.
In summary, by registering your foreign company to conduct business in California, you have annual filings and fees in two states.
but what about no income tax?
Wasn't the whole point of incorporating in a foreign state to avoid paying state income tax? Unless you are personally domiciled in that zero income tax state, the answer is No!
Consider this - LLCs and S-Corps have pass through taxation, so the profits and losses are allocated to the tax returns of the individual members/shareholders. The entities themselves don't file tax returns. If you are domiciled in California, then you pay income tax to California. Your Nevada LLC doesn't absolve you of tax liability to California.
If you formed a Nevada LLC to avoid state income taxes, but you are domiciled in California, then you are going to pay income tax, and the entire purpose for incorporating out of state was frustrated.
Even worse, you will have to register your business in California (if you are transacting business here), and that entails fees and paperwork to both states. You also must submit annual filings and fees to both states, and appoint a registered agent in both states.
In closing, if you're considering forming your LLC or S-Corp. out of state to avoid income tax, and you are domiciled in California, I hope this article gives you pause. Go speak with your tax professional to corroborate your tax savings theory. If you have already formed the entity out of state and are domiciled in California, you might consider dissolving the foreign entity and forming a new entity in your home state.
Being in business is hard enough, and you shouldn't complicate your life with unnecessary paperwork and fees.