Doing business in other states—known as foreign qualification—can often be confusing. It may sound like an international concept, but “foreign” doesn’t mean something outside of the United States when it comes to U.S. corporations and limited liability companies (LLCs). It’s really about operating domestically in the U.S., but outside of the state in which you incorporated your business.
What is foreign qualification?
Foreign qualifying is simply registering to do business in a state other than the one in which you incorporated. That’s because corporations and LLCs are considered domestic only in their state of incorporation. For example, if you form an LLC in Delaware, it is only domestic in Delaware and considered a foreign LLC in other states.
Foreign qualification process and requirements
When you foreign qualify a business, you register for a Certificate of Authority in the state(s) where your company will do business and pay required state fees. This notifies the state that your company is conducting business within its borders. Remember: your business will be subject to ongoing reporting requirements, fees and taxes in both your state of incorporation and state of qualification. If your business expands into new states and you need to foreign qualify, these initial and ongoing fees should be considered a necessary part of doing business.
Do you need to foreign qualify?
If you are currently evaluating whether to incorporate in a state other than one where you are located (your home state) such as Delaware or Nevada, you should consider whether you may need to foreign qualify in your home state. There are many factors used in determining the need to foreign qualify. While different states have different criteria for transacting business, consider the following:
- Does your company have a physical presence in the state?
- Does your company have employees in the state?
- Does your company accept orders in the state?
- Does your company have a bank account in the state?
If you answered yes to any of these statements, you will likely need to foreign qualify your business in the state.
If you’re still not sure if you need to foreign qualify, you may want to get the advice of an attorney.
Consequences of not foreign qualifying
Since there are additional costs—including initial and ongoing fees from both your state of incorporation and state of qualification—you may wonder if the process is really necessary. But state laws require foreign corporations and LLCs doing business within their borders to foreign qualify, and the consequences of not doing so outweigh the costs:
- You may lose access to that state’s court system. For example, if an employee or customer within a state in which you do business sues your company, you can’t defend the lawsuit in that state, because your company is not recognized as a business there.
- You may face fines, penalties and back taxes for the time in which your company did business within a state without being foreign qualified there.
Foreign qualify or incorporate in every state?
An alternative to foreign qualifying is to incorporate your business or form your LLC in the other state(s) in which you plan to do business. The primary difference is that when you incorporate or form your LLC in multiple states, your company becomes domestic in each of those states, thereby creating separate entities. Consider the following in making your decision:
- Increased corporate formalities. For corporations, the increase in corporate formalities is a big disadvantage. Corporate formalities include drafting and maintaining bylaws; issuing stock and recording all stock transfers; holding initial and then annual meetings of directors and shareholders; and keeping minutes of all director and shareholder meetings with the corporate records. LLCs do not face the extensive formalities imposed on corporations.
- Separate owners and management. When you create a separate corporation in each state, each has its own stock, shareholders, directors, and officers. Even if they are the same people for each, the formalities apply for each domestic corporation, greatly increasing the annual record-keeping requirements.
- One company versus separate companies. When you foreign qualify, only one corporation or LLC exists. For corporations, regardless of the number of states in which it foreign qualifies; it needs only one set of bylaws, stock, shareholders, directors, and officers. Record keeping for initial and annual meetings of directors and shareholders happens only once.
- Separation of liability between businesses. Forming a new corporation or LLC in each state provides liability separation. For example, if one of your companies is forced into bankruptcy in one state, company assets in the other states typically are not used to pay for the bankrupt business. If you have foreign qualified in each state, only one corporation or LLC exists, so there is no separation of liabilities.