What State Should You Use for Your LLC?

Generally speaking, from a tax perspective, the best place to form your LLC is the state where it’s going to do business. In a real estate LLC, that means where the property is located. In a business LLC, that means where the business is located. If it’s an online business, it means where you are located – or where the work is actually being done. But it’s also important to look at privacy concerns, asset protection and state laws.

Location and Tax Nexus

Taxation is going to play a major role in determining your LLC’s jurisdiction. Taxation happens wherever your business has nexus.

Nexus is a term that means presence and liability for taxes. Your business can have nexus for income tax, or it can have nexus for sales tax … or both, depending on individual state laws. A nexus determination is entirely dependent on state laws, which are evolving at a furious pace.

For example, if your business has a physical location in a state, it has nexus in that state. A physical shop in New Jersey means New Jersey nexus. Owning real estate in a state means automatic nexus in that state.

Those are the easy ones. But nexus can also be created in many other ways. If you have an employee who works from home in a separate state you could have nexus in that state, depending on state law and the employee’s role. In some states, the existence of an employee in an administrative role will trigger nexus. California is one such state. In others, nexus is triggered only if the employee provides service to customers in that state, or is selling your products and services in that state. So a bookkeeper who just works for your business may or may not trigger nexus, whereas a salesperson inevitably will.

You can also trigger nexus by going into other states. If you cross state lines to provide service, maintenance, or deliver goods personally, you’ll create tax nexus.

Here are some other ways you can create nexus for your business, depending on the state:

Advertise in a state, including phone books, billboard, or having a local phone number or answering service,

Attend trade shows, whether or not you sell products or simply give away information

Enter into affiliate relationships with sellers who will promote your products in Colorado, Oklahoma, New York, North Carolina or Rhode Island (this list is growing)

Store goods in a warehouse, or have a drop-ship relationship with an existing warehouse operation

Own physical property in a state

Live in a state

Hire independent contractors to help you out in a state, particularly if you are their main source of income

Earn a certain percentage of your overall income in a state

Sell digital downloads into a state

Have your website hosted on a server in a nexus state

The last three are particularly concerning, because they can impact you even if you have no physical contact with the state. There are now 17 states who will attempt to assert the right to tax your business if it is hosted on a server and delivering products within their state. There are 25 states who consider digital download to be subject to sales tax, and over three-quarters of the states have adopted some type of economic nexus law. Economic nexus means that they will be looking to your business for income tax if you make over a certain amount from selling goods or services to customers in those states.

You will also need watch how you advertise and sell. There are some states who will consider your business fair game if you exhibit at a trade show, even if you aren’t taking orders or selling products. There are businesses who will try to tax you if you’re a traveller, and come into their state to work.

As extreme as some of these examples seem, they also represent the new tax reality. There is huge pressure on state governments to increase revenues. Online businesses are tempting targets, especially those from out of state (amongst other things, they can’t vote). Make sure that talking to your CPA or tax advisor about your potential nexus issues is part of your pre-planning process. Tell your advisors about your business, what it’s going to do, and where. If you’ve got multi-state issues to consider, it’s far better to know what you’re getting into ahead of time while there are still plenty of planning opportunities to minimize the tax hit.

This is an issue that won’t go away anytime soon.

There are many variables when you’re structuring a business. That’s why it’s hard to go through a quick-service website. Unless you talk to someone who’s got some knowledge and experience on both the tax and the legal side, it’s hard to know what you don’t know. And that can leave you vulnerable.

Got questions? Contact us! We’re here for you.

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