We just listed out the three most debtor-friendly states, but that’s where it ends. You might have heard that you can avoid taxes by forming an LLC in Wyoming or Nevada- is that true? Sure if tax fraud comes easy to you. Sorry Charlie, your profits will technically be allocated to the states in which you operate. Here is a sample allocation (or some say apportionment) which some states use to calculate your tax liability-
So, yes, under nexus rules perhaps a small portion of your profit can be attributed to Nevada- yet, this is not because you were incorporated in Nevada, it’s because you had a presence in a state that does not impose an income tax. Same would be true for all your sales in Wyoming, Washington, Texas, South Dakota, etc. where strict corporate income taxes do not exist. In addition, several states impose a gross sales receipts tax and other forms of alternative minimum tax although their corporate income tax rate is zero.
Note: This is a sample. Some states gives sales a larger weight. Others ignore payroll and property. Talk to your apportionment buddies at the Watson CPA Group.
Those customers in that jurisdiction perhaps enjoy a smaller tax rate and are able to have more purchasing power. That smaller tax rate might be offset by higher tax rates for the businesses. Business A (Best Buy in this example) has to subsidize the customers in the taxing jurisdiction while Business B (you) does not. Best Buy would be a bit upset in this example.
Avoiding taxes is the American way. We get it. But something about the 14th Amendment and equality and pursuit of happiness comes to mind. Then there’s that darn 16th Amendment.
States define economic presence differently. Some states, such as California, use a sales dollar threshold (sometimes referred to bright-line) to determine nexus. The Watson CPA Group is getting close to having enough California business to necessitate filing as a foreign entity there just based on revenue. Yuck, since the income tax rate is twice as much as Colorado’s. California also has a presence test where if you have an agent working for you in California, then you have income tax nexus.
Remember, this is only income sourced to that taxing jurisdiction. About half the states have nexus rules and thresholds. Can’t get enough? Here is a Journal of Accountancy article from 2010-
Don’t forget the basics such as bank accounts, licenses and permits. If you must be licensed in another state to legally conduct business such as an agent for an insurance business, this in itself might create nexus.
This book dives deep into the issue of nexus in a later chapter, with topics such as sales tax, FBA (Fulfillment By Amazon), throwback rules, and interstate commerce rules. With the recent South Dakota v. Wayfair U.S. Supreme Court case, the sales tax nexus is going to be transformed over the next several years.
Conversely, you might simply want to create another LLC in the satellite state. This allows you to separate financial liability- for example, you might get sued in one state with unfavorable tax laws yet protect your interests in the other state (separate LLC). Bankruptcy laws change by state as well. Something to consider.
Nevada Fallacy Recap
Another example to chew on- you have a home office in Maryland. You commute to DC to work for your only client. You incorporate in Maryland since that is where your home office is and you pay yourself a wage subject to Maryland income taxes. Wait there’s more. You also have a presence in Washington DC requiring a DC corporate tax return as a foreign entity in addition to your Maryland corporate tax return. Thankfully these and other jurisdictions have reciprocity rules.
The bottom line is that Nevada tax laws benefit business owners with a presence in Nevada. As Zig Ziglar would say, You might get a free lunch on consignment, but eventually you’ll have to pay. We encourage you to not game the system, and if you want to, the Watson CPA Group cannot be a part of it- we have too many clients relying on us to do the right thing. Pay your fair share of taxes, just not a dollar more.
Having said that, there are a zillion reasons why forming a corporation in a tax friendly state does make sense. But those are case-by-case scenarios. Nothing is a slam-dunk or carte blanche either way. The right questions must be asked and answered to reach the best decision.
Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition