Due to California’s high income tax rate, sometimes there is a temptation to try to form a business through Nevada, which does not have an income tax. However, this is not a valid strategy for several reasons.
First of all, even if the business is legitimately in Nevada and satisfies the rules to be a non-resident California business, if the business is an S Corporation, Partnership, or pass-through LLC, the taxable income passes to the owner. If the owner is a resident of California he/she would have to pay taxes on all of the business income regardless of the state the business is located in because California taxes all income of its residents. Therefore, the income tax to the owner would be very similar whether the business was in Nevada or California. This scenario would provide some small relief from mandatory fees but the benefit would be small compared to the burden of actually becoming a resident of Nevada.
Additionally, even a C Corporation would have potential problems. With a C Corporation the owners do not pay income tax on the taxable income until they actually receive a dividend or some other form of compensation. As such, a Nevada C Corporation would not have to pay any California tax. This is where the problem lies. If the C Corporation is managed or controlled from within California, it is considered to be a resident of California, regardless if it is incorporated in Nevada. The standard to avoid being a California Corporation is very high. To avoid California making this classification and imposing tax, at a minimum the Corporation would likely need corporate offices in Nevada, meetings in Nevada, business decisions made in Nevada, and basically all business activity directed from Nevada. If the very high standard cannot be met, the corporation will be considered a resident of California and California will tax all of its income.
As you can see simply incorporating or forming a business in Nevada does not provide much if any benefit with respect to California taxes. Taxpayers should be sure they are making decisions based on what is best for the business and that these decisions have the intended effect. If you have questions regarding your business’ tax obligations contact us at Hone Maxwell LLP today. Also, you can follow us on twitter @HMLLPTax or facebook at www.facebook.com/HoneMaxwellLLP for more tax tips and the latest updates on tax news.
