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Setting UpOut-of-State Entities if You Are Based in California

People in California often ask if it is advantageous to set up an out-of-state entity to avoid taxes. Nevada is most often mentioned, because it has no corporate income tax and no personal income tax. Despite this, often there is no tax advantage to doing so – and it often is more expensive.

A California resident pays California tax on all of his/her income, even if that income comes from outside California.

It is very difficult to establish residency outside of California if you are doing anything in the State. Generally, California takes the position that someone is not a California resident only if:

If you are present in California for more than 9 months in any given tax year, the State presumes that you are a resident. For details, see the Franchise Tax Board’s Guideline for Determining Resident Status, which can be found athttp://www.ftb.ca.gov/forms/misc/1031.pdf.

If you set up a Nevada limited liability company (LLC) or Subchapter S corporation, since the profits flow through to the owners, any owner who is a California resident will be taxed on all the profit (and compensation) that he/she receives.

It is possible to set up a Nevada "C" corporation, but this has its own disadvantages. Although the "C" corporation will pay no Nevada income tax, it will pay federal income tax on any profits that it has. Also, if you take any salary or dividends from that corporation and are a California resident, you will pay California income taxes on that money – and you’ve just been hit with the "double taxation" issue that can be avoided by forming an LLC or Subchapter S corporation. In addition, California will tax an out-of-state entity on income it earns in California.

Finally, if you have an out-of-state corporation or LLC but have headquarters or any office or "presence" (telephone number, home office, P.O. Box, etc.) in California, you have to register that LLC or corporation as an out-of-state entity with the State of California – and the filing fees and minimum annual tax are the same as if you set up the entity in California. Given the additional costs of setting up an out-of-state entity, frequently going that route is more expensive that simply using a California entity in the first place.

In short, unless you plan on meeting the test to NOT be a California resident, you usually aren’t going to save any money by setting up an out-of-state entity – and it may well cost you more than setting up a corporation or LLC in California.