California - When is an LLC Doing Business in the state?

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When is an LLC
Doing Business in California?

How to form an LLC in California
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)

(check out Northwest vs LegalZoom)

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.

Matt Horwitz
Founder & Educator, 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! LLC University® teaches people how to form an LLC for free in all 50 states. We hope you find our free guides and resources helpful in your business journey.
Disclaimer: Nothing on this page shall be interpreted as legal or tax advice. Rules and regulations vary by location. They also change over time and are specific to your situation. Furthermore, this comment section is provided so people can share their thoughts and experience. Please consult a licensed professional if you have legal or tax questions.

14 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
  2. Sarah January 7, 2019

    Hi Matt,

    This site is awesome — well done.

    Question for you, if you don’t mind.

    My family and I are starting an online business together, and plan to form an LLC. One of us live in California , and the other two live in Arizona. Looking at options, can we form the LLC in Arizona with just the two of us ?

    Thanks for the great info here.

    Jolie

    reply
    • Matt Horwitz January 7, 2019

      Hi Jolie, thank you. It comes down to where you’re transacting business. Because the one member resides in California, you’re likely doing business in California and Arizona. You may want to look into forming an LLC in Arizona and registering as a foreign LLC in California or vice versa. Hope that helps.

      reply
  3. Melissa Tierra January 8, 2019

    Thank you so much for your articles! My business was about to form an LLC in DE (while we live in CA) as some people had recommended it would save us money. After stumbling on your website and reading your articles yesterday, I did thorough research, and realized this was a terrible idea! You saved us $$ and headaches…very much appreciated! Happy New Year!

    reply
    • Matt Horwitz January 8, 2019

      Hey Melissa! So happy to hear that. While you can form an LLC in Delaware, you’d ultimately have to register it as a foreign LLC in California. Glad you found this article. This is the heart of it all. It comes down to where you’re transacting business. Happy New Year :)

      reply
  4. Brian Philip January 22, 2019

    Matt, I’ve thoroughly read your Q&As and didn’t see my question answered— I’m doing business in primarily 2 or 3 states (CA, TX, FL) in real estate (will be buying/selling and renting out my properties) I am originally from one (CA) and will be moving to Florida as I like the market there and the weather. But for instance when I move to FL I’ll keep my house in CA and rent if out for minimal cash-flow (after mortgage/ insurance/ property taxes/ upkeep etc.) and then I’ll be renting a single property out in FL while also living there and trying to find/ flip other real estate in FL… and then in TX I’ll have a rental property garnering some cash-flow… I know you’ve said to LLC in same state(s) in which anyone will be doing business in, but what if you’re truly doing business in 2, 3, or 4 states in real estate? This can’t be that uncommon, especially for people from smaller closer bordered states doing real estate business in a handful of clumped nearby states… Is Delaware LLC still a good option to consider, or is it good to research the best out of the proposed states (in my case TX, CA, FL and possibly outside chance N.&S.Carolinas). Any input? Greatly appreciated

    reply
    • Matt Horwitz January 22, 2019

      Hey Brian, we’re currently working on a large piece about transacting business. But it’s a beast and will take some time. Every state has different laws. In short though, it comes down to where you’re transacting business. And like you said, you’re doing business in CA, TX, and FL. It’ll be best practice to have a conversation with a real estate attorney (or a few). You’ll want to discuss forming an LLC in each state (for each property) vs. forming an LLC (say in FL) and registering as a foreign LLC in all states where you’re doing business vs. forming a holding company (say in WY) and that WY LLC owns child LLCs, each set up in the state where there’s property. Or maybe they have a different recommendation altogether. Hope that helps though.

      reply
  5. Chris Lewis January 26, 2019

    Hey Matt. Thanks for the great information!

    My in-laws currently have an LLC organized in California where almost all of their work is performed. I am preparing to take ownership of the service related business.

    Looking at the articles of organization it would appear that we could keep the LLC organization but change the CEO and Manager/s. I live in Utah and will be running the business from here. There will primarily be income earned in California will some being earned in Utah. We will not be able to provide an agent for service of process as seems to be required.

    In your opinion would we be better off creating a new LLC in Utah and registering as a foreign LLC in California? Or, make changes within the currently structured LLC and find a solution to the agent for service?

    Thanks for the help!

    reply
    • Matt Horwitz February 6, 2019

      Hi Chris, a situation like this, which has many variables and details, is best discussed with an attorney. However, what do you mean by not being able to provide an agent for service of process? You can always hire a Registered Agent company instead of being the agent yourself… if that’s what you meant. Does that help?

      reply
  6. AL February 8, 2019

    Hi Matt!!

    Thanks a lot for the article!!

    Please answer my question too :)

    Im a truck driver, I have California driver license. There is one owner in CA, im working as a truck driver on his truck. He gave me 1099 form.

    So question is:
    im plaining to open llc or s-corporation and continues working with this truck owner.
    But, im running throw all states during 24 days in month. I don’t have any home in CA. Im always working.

    So should I pay CA state tax at the and of the year? or I can open LLC or S-corporation in WA, or some other state with 0% state tax and pay no state tax? because in fact I spend my almost all time in truck.

    Thank you for help!

    reply
    • Matt Horwitz February 14, 2019

      Hey Al, you’re very welcome! It’s best practice to have this conversation with a tax attorney or a qualified tax professional. Based on what you said, it sounds like you have residency and domicile in California. Therefore, California will deem you responsible for filing state income taxes as well as the California LLC franchise tax. So even if you formed an LLC in Washington, that Washington LLC would need to be registered as a foreign LLC in California. Furthermore, even with a Washington LLC, you’d still pay state income taxes in California. And if you elect to have your LLC taxed as an S-Corp, you’ll need to pay payroll taxes. Those are filed at the federal, state, and local level. State and local payroll should likely be paid in California. In summary, it’s likely best to form the LLC in California. Having said that, this is just a general reply.

      Also, it’s important to note that you don’t “form” an S-Corporation. An S-Corporation is a federal tax election (aka tax entity) that “sits on top of” a state entity, like an LLC or Corporation. When most websites talk about “forming an S-Corp”, they are technically referring to forming a Corporation and then electing to have that Corporation taxed as an S-Corporation (instead of a C-Corporation). However, an LLC can also elect to be taxed as an S-Corp. We have more info on that here: LLC making S-Corporation election.

      reply
      • Al February 14, 2019

        Thank you for answer!

        So as I understand I need to change my residency. As I understand, I should change just my California driver license on, for example, nevada or texas driver license and after that I will have nevada or Texas residency and its open for me the possibility for llc with no tax and without out of state llc function.

        Am I right?

        reply
        • Matt Horwitz February 15, 2019

          Hi Al, you’re welcome. We can’t comment specifically on it, however, if you actually move and change your residency, then that’s where you’ll be responsible for paying state income tax, if any. And yes, you can form your LLC in that state, too.

          reply

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