The United States is not as united as you think; each state has its own compliance obligations, which makes your business a foreign entity in the other 49.
Our US expert looks at foreign qualification for US compliance.
A US corporation, limited liability company or other statutory business entity is a “domestic” entity in only one state – its formation state. A business entity is considered a “foreign” entity in all other states. Every US state has the power to prohibit foreign entities from doing business within their borders – or to permit them to do business only if they comply with certain conditions the states deem necessary.
Every state has taken advantage of this power by enacting foreign qualification provisions in their state business entity laws. Entities must comply with these provisions in order to receive authority to transact business in a foreign state and to have access to the state’s courts.
It is common for business entities to conduct activities in, or have contacts with, states outside of their formation states. When this occurs, qualification may be necessary, but it can be a difficult determination.
What is qualification?
Qualification is the procedure by which a statutory business entity receives the authority to transact business in a state other than its formation state. It is a relatively straightforward process that builds upon the entity’s primary formation obligations in its home state.
In general, the business entity pays a fee and files a document with the state business entity filing office, usually the secretary of state’s office. Upon authorisation, the entity receives a certificate or other evidence, allowing it to do business as a qualified foreign entity in the state.
The filed document is generally known as an application for authority. Typically, it consists of a short form that asks only for certain basic information about the entity, such as legal name, jurisdiction of formation and office and director details.
In most states, this application must be accompanied by proof of formation in the home state. Generally, a certificate of existence must be filed to meet this requirement, providing evidence from the formation state that the entity has been validly formed and is up-to-date in filing the reports and paying the taxes required to stay in good standing.
Once qualified, the entity will be subject to other compliance requirements, most notably the maintenance of a registered agent and the filing of an information report.
The consequences of a failure to comply
A foreign entity that transacts business in a state without qualification is subject to penalties. Often, a monetary penalty is imposed on the entity for each year that it should have been qualified. For example, California imposes a $20 per day penalty on entities that failed to qualify.
But it may not end there. Under some state statutes, individual officers or agents doing business on behalf of the non-complying entity may be fined. A state may also collect all fees and taxes the foreign entity would have owed had it qualified when required to, plus interest, and in some cases additional fines.
The foreign qualification provisions could also prohibit a foreign business entity conducting intrastate businesses from bringing a suit or proceeding in the state’s courts until it qualifies. This is referred to as a “door closing” provision. The guiding principle is that a foreign entity should not benefit from the aid of a state’s courts in enforcing its rights when it is (a) violating state law and (b) not paying its fair share - unlike the state’s domestic and qualified foreign entities.
What qualifies as “doing business” across state lines?
Typically, if an entity has a physical location and/or employees on the payroll outside of its home state of formation, it may be doing business as a foreign entity.
An Internet-based business, which engages in interstate commerce, may not need to foreign qualify in other states if its physical locations and employees are only located in its home state of formation. It is also important to be aware that the nexus for tax purposes is not necessarily equivalent to the need to qualify as a foreign entity.
The benefits of conducting business activities across state lines are numerous for many entities, but compliance complexity increases with this expanded business reach. Every state has the power to impose conditions upon foreign business entities before allowing them to do business within its borders. A business that does not comply with these provisions does so at its own peril.