One of the most significant issues facing business owners is whether they need to register to do business (or qualify to do business) in a foreign state (a foreign state merely refers to a state other than that of the state in which the business is incorporated). This issue is often raised by the CPA when doing tax preparation or considering tax planning strategies.
If the business has sufficient nexus (contact with a state), it is subject to that state’s income, franchise, gross receipts, sales, or other tax. The explanation of nexus is beyond the scope of this post, but has been addressed in earlier posts.
Some business owners are reluctant to register to do business in a foreign state for a host of reasons. The reasons may include a belief that the amount of taxes paid will increase (which is not always the case), tax preparation compliance cost will increase (which is a fact), or that if the issue is ignored, it will go away. We refer to ignoring the issue as the Ostrich Approach. The business owner buries his/her head in the sand and hopes that the problem goes away, ignoring the fact that the ostrich’s butt is exposed.
Let’s take a look at some of the consequences of using the Ostrich Approach. Since these are mostly legal consequences, legal counsel needs to be consulted by the business owner.
- The LLC (or corporation herein after) may be prohibited from bringing a legal action in the courts of that state or transacting any further business in that state.
- The LLC may be subject to penalties, taxes, or other fees for failing to qualify to do business before conducting business.
- The LLC may face legal battles to defend the validity of contracts executed in the state before the LLC qualified in that state.
- Some state statutes impose joint and several liability on those who act as a LLC before registering their companies under state law. Thus the owners of the LLC could find themselves being sued individually for the actions and debts of the LLC.
- The potential tax assessment never goes away. Since no tax returns are being filed in these other states, the statute of limitations never expires. Thus, an assessing state can go back to year one of nexus and assess taxes, plus interest and penalties.
- Double taxation could be imposed. The LLC had paid its state taxes when its returns were originally filed, and then years later a state assesses additional taxes for the activities within its state. If the statute of limitation has closed for the earlier tax years, the LLC cannot file amended tax returns in those states and winds up paying taxes a second time on the same income.
Note: Because nexus varies by state and by type of tax (income, franchise, gross receipts, sales, etc.), we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation.
You can also schedule a consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
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