As California continues to be one of the more expensive states to conduct business in, many owners may be considering moving their business to another, less expensive state.
Before packing your bags and crossing the state line, there are a few regulatory updates and tax considerations to keep in mind.
First, California will continue to require your entity to file California income tax returns and pay at least an $800 minimum tax if your entity is considered to be “doing business” in the state. Doing business is defined as actively engaging in any transaction in California for the purpose of financial or pecuniary gain or profit.
This definition is broad. However, under California’s economic nexus rules, an entity is also considered to be “doing business” in the state if any of the following apply:
The following example illustrates the economic nexus rules. Corporation A, an out of-state seller of tangible goods, has no property or payroll in California. During tax year 2012, Corporation A has $1,000,000 of sales in California. Corporation A will have a California filing requirement for tax year 2012 and will be subject to the $800 minimum tax.
Essentially even if an entity does move out of state, if it has a physical presence (i.e., employees, office space, etc.) or is tapping into the California market, there is a good possibility it will still be caught up in California’s tax web.
Secondly, owners of a flow-through entity (i.e., a limited liability company “LLC”) who reside in California will be subject to California income tax on the flow-through entity’s income regardless of where the business is organized. California taxes its residents on their worldwide income without consideration as to the income’s source.
Unfortunately, relocating a California LLC to Nevada with members who continue to reside in California, will not help with the tax bill. Furthermore, a flow-through entity is considered to be doing business in California if it has general partners or managing members in-state.
If it really is time to relocate to another state, there are several options on how to get there depending on whether the business is organized as a corporation or as a flow-through entity.
A business organized as a corporation has three available options:
The following factors should be considered before choosing one of the available options.
California minimum tax: If you maintain the old corporation in California or are considered to be “doing business” in the state, as discussed above, the corporation must continue to file California income tax returns and pay the $800 minimum tax.
Federal tax issues: Liquidating a corporation may result in a tax train wreck to both the business and its shareholders. For example, when a C corporation with appreciated assets liquidates, it must recognize gain inside the corporation equal to those assets’ fair market values less their carrying costs. Shareholders who receive the company’s assets upon liquidation must also recognize a taxable gain if the carrying value of their shares is less than the fair market value of the assets received in liquidation.
Reorganization: For a C corporation, a reorganization can be accomplished entirely tax-free. There is no tax on the merger of the old corporation into the new one. It’s as if there had been no change for federal tax purposes, but the merged corporation does cease to exist in its original state.
Dissolution costs: If you dissolve your business and either form a new one or merge it into a new corporation, you must go through the formalities of dissolving the old one. Generally, this process requires filing dissolution paperwork with the California Secretary of State and ensuring all outstanding tax filings and tax liabilities are current.
A business organized as an LLC has similar choices to that of a corporation:
Overall, moving your business out of California is easier said than done and requires careful consideration to ensure you adhere to regulatory compliance and end up at your ultimate destination point.
