Foreign Entity (LLC) Question - Online Business

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Latest post Thu, Feb 16 2017 11:47 PM by robbyfine. 9 replies.
  • Tue, Jan 3 2017 11:05 AM

    Foreign Entity (LLC) Question - Online Business

    Hi everyone, I have a general inquiry about forming a foreign entity (LLC) in South Carolina. I've done a bit of research online already but would like to confirm my findings and hear the thoughts from a reputable law community.

    First let me explain a little bit about my company.  We provide managed IT solutions to small businesses across the country. I originally just let everything run as a sole proprieter but as things have grown I'd like to change that. I currently reside in South Carolina. We do not have a storefront or physical office building within South Carolina, I do all the work from my home. There are no employees (I use independent contractors from across the country when needed) in South Carolina, or anywhere else really, besides me.  I currently do not have a business bank account in South Carolina, but may want one in the future.

    I plan on forming an LLC in the state of Delaware. If there's any real reason to go with an S-Corp at this beginning stage, please let me know, but all my findings have pointed me towards an LLC. Now to the real crux of my question. Once I form the LLC in Delaware, I'll obviously continue living in South Carolina. While I don't have any employees or an office building here, I do conduct business here in the sense that I meet with clients remotely, call leads, maintain the services, etc.

    After forming an LLC in Delaware, do I need to file as a foreign entity in South Carolina? 

  • Tue, Jan 3 2017 11:24 AM In reply to

    • DOCAR
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    Re: Foreign Entity (LLC) Question - Online Business

    The simple answer is yes.  What compelling reason is there to pay double fees and file double reports if you form an LLC in Delaware?  There are business reasons having to do with officer and director liablity, shareholders suits and the like for incorporating in Delaware, but I have yet to see a compelling reason to incorporate or form and LLC in a state other than the one you are doing business in for a sole proprietorship.

  • Tue, Jan 3 2017 12:14 PM In reply to

    Re: Foreign Entity (LLC) Question - Online Business

    Well, the reason I was a sole proprietor initially in South Carolina is because I live here and the business was very small. Over the past 18 months we've gone from about $2,000 a month in revenue to on average $18,000/month. Being a sole proprietor doesn't make sense anymore for the lack of asset protection and high tax burden. Hence why I want to form an LLC.

    Delaware is an ideal place to form an LLC due to the lower corporate tax rate compared to South Carolina. Also the environment is much friendlier to businesses than in most states and gives me breathing room for growth in that regard (changing to S-Corp in future, leaving intangible assets with the Delaware company, etc). 

    I, personally, couldn't find much of a reason to need to file as a foreign entity in South Carolina once I formed the LLC in Delaware because, as stated, I a.) do not have a storefront in South Carolina b.) have NO employees in South Carolina. The only worry I really had was if I wanted to open a business checking account in South Carolina, but if I can just open one in Delaware and avoid having to file as a foreign entity I'd rather go with that.

    I'm doubtful to change my mind on incorporating in Delaware, even if I have to file as a foreign entity in South Carolina. Then 5% difference in taxes I'll save is worth it. I'm just trying to figure out if I absolutely NEED to file as a foreign entity in South Carolian due to the nature of my business.

  • Tue, Jan 3 2017 12:21 PM In reply to

    Re: Foreign Entity (LLC) Question - Online Business

    GaryTaylors:

    After forming an LLC in Delaware, do I need to file as a foreign entity in South Carolina? 

    Yes, you do. Your location is the headquarters for the business, all the administrative work is done there, you meet with clients there, etc. That is very much doing business in the state. 

    For a closely held non publicly traded business entity there is usually no significant benefit to organizing in any state in which you do not do business and are not required to file. So unless you do business in Delaware such that you would have to register there as a foreign LLC (assuming you organized it in SC) then you likely will not benefit from organizing in Delaware. What you will do instead is increase the filing fees for having to file in two states instead of just one, increase the reports you file to two states instead of one, and increase your complexity in having to deal with registered agents in two states, etc. Note that organizing the company in Delaware will not save you tax, as many people seem to think.

    I see lots of clients that come in wanting to organize in Delaware, Nevada, or Wyoming even though they do no business in those states based on the idea that if big corporations do it then it must be the best way to go. But the reason big publicly traded corporations organize in Delaware is mostly due to things that would not matter to a single owner LLC. Delaware law has rules favorable to management in disputes with shareholders. Delaware has a specialized court that resolves shareholder/management disputes pretty quickly. Delaware has rules that make the company stock a bit more attractive on the stock exchanges. Those are why the big corporations organize there. Moreover, since the big corproations do business nationwide, its no additional burden to organize there anyway. If your business ever gets big enough to the point where these kinds of concerns matter, it is very easy to change the state of organization from South Carolina to Delaware. 

    As far as S-corporation status, understand that S-corporation is NOT a type of entity you create with the state. S-corporation is a federal tax term referring to a business entity that has elected to be taxed under Subchapter S of the Internal Revenue Code (IRC). It started as a way for corporations to get tax treatment similar to partnerships. Under present regulations, any domestic entity that meets the ownership requirements may elect to be taxed as a S-corporation. This means you could have your South Carolina (or Delaware) LLC elect to be taxed as a S-corproation if you wanted. You can start with the LLC not making the election (and thus taxed as a sole proprietorship if it has just one owner) and make the election later on if the S-corporation status would be more helpful. Whether it would be a good way to go now depends on all the details of your business, which I obviously do not know. You might want to meet with a tax attorney to help you decide the best way to organize the business. 

  • Tue, Jan 3 2017 12:30 PM In reply to

    Re: Foreign Entity (LLC) Question - Online Business

    GaryTaylors:
    I'm doubtful to change my mind on incorporating in Delaware, even if I have to file as a foreign entity in South Carolina. Then 5% difference in taxes I'll save is worth it.

    No, you will not save that 5% in tax just by changing your place of organization. It is critical you understand this. A single member LLC that does not elect to be treated as a S-corporation is taxed like a sole proprietorship — so you will be taxed just like you are now. Delaware always follows the same classification of the business entity as the federal classification. 

    Corporations are taxed for state income tax in pretty much every state based on formulary apportionment. That is, they use a formula to determine what portion of your income derives from doing business in that state. Thus, even as a corporation, you would have to file income tax returns in both states. And guess what? If you have no activity in Delaware, you will pay no tax there (and the lower rate won't help you) and if all your activity is in SC it is still SC that will tax the income. In short, you don't end up realizing a tax savings just by shifting you state of organization. State laws don’t allow that kind of easy end run around their taxes.

    Edited to add this: Organizing in Delaware will not make it easier to convert the LLC to a S-corporation. The S-corporation election is made with the IRS; it has nothing to do with state law or in what state you organize. The process is exactly the same (and quite easy) whether the LLC is organized in Delaware or South Carolina. 

    You have some common misunderstandings about what organizing in Delaware will do for you. It does not have all the advantages for you that you seem to think it does. 

  • Tue, Jan 3 2017 12:49 PM In reply to

    Re: Foreign Entity (LLC) Question - Online Business

    GaryTaylors:
    I'm just trying to figure out if I absolutely NEED to file as a foreign entity in South Carolian due to the nature of my business.

    Doing business in the state is broadly construed. The state statute lists those things that are NOT considered to be doing business in the state. If you do much of anything other than the things listed there, you are doing business in the state and need to register as a foreign business entity there if the LLC is organized in Delaware; That list of things thare are not considered doing business in the state is found in SC statute section 33-44-1003, which states:

    _____________________

    SECTION 33-44-1003. Activities not constituting transacting business.

    (a) activities of a foreign limited liability company that are not considered transacting business in this State within the meaning of this article include:

    (1) maintaining, defending, or settling an action or proceeding;

    (2) holding meetings of its members or managers or carrying on other activity concerning its internal affairs;

    (3) maintaining bank accounts;

    (4) maintaining offices or agencies for the transfer, exchange, and registration of the foreign company's own securities or maintaining trustees or depositories with respect to those securities;

    (5) selling through independent contractors;

    (6) soliciting or obtaining orders, by mail or through employees or agents or otherwise, if the orders require acceptance outside this State before they become contracts;

    (7) creating or acquiring indebtedness, mortgages, or security interests in real or personal property;

    (8) securing or collecting debts or enforcing mortgages or other security interests in property securing the debts, and holding, protecting, and maintaining property so acquired;

    (9) conducting an isolated transaction that is completed within thirty days and is not one in the course of similar transactions of a like manner;

    (10) transacting business in interstate commerce; and

    (11) owning, without more, an interest in a limited liability company organized or transacting business in this State.

    (b) For purposes of this article, the ownership in this State of income-producing real property or tangible personal property, other than property excluded under subsection (a), constitutes transacting business in this State.

    (c) This section does not apply in determining the contacts or activities that may subject a foreign limited liability company to service of process, taxation, or regulation under any other law of this State.

    ___________________________________

    I strongly advise you to get advice from a SC business attorney and tax attorney to get this right. The fees you pay for good advice will save you a lot more money and wasted effort later on should you get this wrong by doing it yourself.

  • Tue, Jan 3 2017 1:08 PM In reply to

    Re: Foreign Entity (LLC) Question - Online Business

    Thank you very much for the detailed responses! The only other question I have is, with how my business is right now, I have clients in about 47 out of 50 states. They and their businesses happen to reside in those variety of states, but I do all the work for my clients in South Carolina. From what I understand, simply having clients in those states doesn't constitute a need for registering as a foreign entity in all 47 states - would you agree with that? Thanks!

  • Tue, Jan 3 2017 1:39 PM In reply to

    Re: Foreign Entity (LLC) Question - Online Business

    GaryTaylors:
    Thank you very much for the detailed responses! The only other question I have is, with how my business is right now, I have clients in about 47 out of 50 states. They and their businesses happen to reside in those variety of states, but I do all the work for my clients in South Carolina.

    The details of your business matter, and so all I can say is that generally speaking if all the business activity occurs in SC then you typically would not need to register the LLC in those other states. However, if you have frequent meetings with clients in those other states or other activity in those other states to carry out your business that might rise to the level of doing business there. 

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