When is an LLC Doing Business in California?

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When is an LLC Doing Business in California?

Quick Start Guide
This Quick Start Guide is a brief overview of how to form an LLC in California.

Detailed Lessons:

 

California LLC Costs:
California state fee: $70
Statement of information: $20 (every two years)
Annual franchise tax: $800 (every year)

Need help?
Hire a reliable service to form your California LLC:
Northwest ($39 + state fee) or LegalZoom ($149 + state fee)

The purpose of this article is for those who feel the California LLC Annual Franchise Tax of $800 per year is too high, and instead, they are wondering if they should form an LLC in another state.

If you live and work in California, and you form an LLC in another state, you are required to register that out-of-state LLC as a Foreign LLC in California. This creates 2 LLC filing fees, a Registered Agent in the foreign state, annual reports in both states, and possible state and local tax obligations in the foreign state (and in CA, of course).

So this begs the question, what does it mean to “do business in California?”

What Constitutes Transacting/Doing Business in California?

The rules of “doing business” vary by state, however, there is one national rule of thumb which most courts will use. A company is “doing business” if a substantial part of its ordinary business is transacted there.

So what defines a “substantial part of ordinary business”?

Of course, this is open to interpretation, but let’s look at a common example to paint some context.

Who: Dave is a 32 year-old US citizen who lives in San Diego, California.

What: Dave is currently a sales consultant. Most of his clients are in California, but he also has a lot of clients across the US. He wants to form an LLC and expand his business. He is planning on doing a lot of business through the internet, creating and selling online courses.

His Thinking: Because Dave is working with clients all over the US, and soon-to-be, all over the world, he is thinking he’s “doing business everywhere”, and therefore, he can form an LLC outside of California to escape the $800 per year LLC Annual Franchise Tax.

Think of it like this: even if Dave formed an LLC in, say Delaware, but he is a resident of California, he already pays state and local taxes in California, primarily works from home in California (or within state borders), makes phone calls from California, accepts contracts while in California, and keeps files stored in his home office (physically or digitally) in California, then it sounds like he’s doing business in California.

Just because Dave is doing business online (who doesn’t these days?), it’s not enough. I’d say, it’s best for Dave to play his cards clean from the start.

What’s the point of forming an LLC in another state just to save $800/year, if it could eventually cost him a lot more (and expose his to risk)?

Sure, the “LLC police” aren’t going to be knocking on Dave’s door next week to check up on him, but there are compliance departments within the California Secretary of State and the Franchise Tax Board, and eventually, he’s bound to get caught and fined.

Further, there are risks to doing business as an unqualified entity in CA:

1. Denied access to California courts (inability to enforce a contract, as an example).

2. Required to file/pay taxes, as well as penalties and fines.

3. Grayness in the law about the ability to bring a counterclaim.

4. Personal liability may arise if you are acting on behalf of an unauthorized entity. While some states have statutes more open to interpretation, California has clearly defined statutes that impose fines on individuals acting for noncomplying foreign entities.

Source: California Corporations Code, Sections 2203, 2258 and 2259.

As for the details on what constitutes “transacting business” in California, here is more info:

“Before transacting intrastate business in California the business must first qualify/register with the California Secretary of State. (California Corporations Code section 2105, 15909.02, 16959 or 17708.02) California Corporations Code sections 191, 15901.02(ai) and 17708.03 define “transacting intrastate “as entering into repeated and successive transactions of its business in this state, other than interstate or foreign commerce.”

Source:
http://www.sos.ca.gov/business-programs/business-entities/faqs/#form-question7

Rather than spend time, energy and money on dodging California’s annual franchise tax fee (which exposes Dave to fines, taxes, and worse, liability), I recommend he instead focus on business growth, product development, marketing, sales, etc.

I like to think of the $800/year as the cost of doing business in CA ;) And unfortunately, I don’t see (nor recommend) any way around it.

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Matt Horwitz
Founder & Educator at LLC University
Forming an LLC shouldn't be so complicated. Our step-by-step guide will make the process a breeze – and no complex legal jargon! We teach people how to form an LLC for free in all 50 states. We hope you find our free guides and resources helpful in your entrepreneurial journey.

2 Comments

  1. Pauline Robinson November 24, 2018

    I live in Ireland and want to create Amazon business in the USA. My business is registered here as a sole trader, can I create an LLC in the USA. I have to pay tax here in my own country and will I also have to pay tax in the USA. I’m told if I register an LLC in Delaware, I will only have to pay a flat rate of 300$ per year is that correct. Is there other fees I would have to pay too. I would also like to know how can get an Agent that I know is legit and not going to be ripped off. I’m not as US citizen any help would be really appreciated. Thank you Pauline

    reply
    • Matt Horwitz November 24, 2018

      Hi Pauline, the $300 Delaware Annual Franchise Tax is better thought of as the LLC Annual Report. Although it is referred to as a “tax”, and it technically is a tax, it’s the not the only type of “taxes” you’re thinking of. You will need to speak with an accountant who works with non-US residents to determine your US tax obligations and filing requirements. Also, the term “Agent” can have multiple meanings. In the context of LLCs, you will need a Registered Agent. If you want to hire a Registered Agent, we recommend Northwest Registered Agent. They can also form your LLC for you if you don’t want to do that yourself. If you hire them to form your LLC, they include Registered Agent services free for the 1st year.

      Once you decide where to form your LLC and it’s approved, you’ll then want an EIN (Employer Identification Number) from the IRS. We have instructions on that here: how to get an EIN without an SSN. And then you’ll want to open a bank account for your LLC: non-US resident US LLC bank account. Hope that helps!

      reply

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