Can I Incorporate My Business in Another State?

If you live in a high tax state--say California or New York--you have probably heard about the idea of incorporating your business in another state for tax savings reasons.

You might, for example, incorporate your California business in Nevada or your New York business in Florida.

Superficial Attraction

By incorporating your business in some other no-tax or low-tax state, so the idea goes, you won't have to pay state income taxes to your state of residence. Or at least you won't have to pay state income taxes on some of your business profits.

Just for the record, as a business owner myself, I agree this all sounds really good. Unfortunately, this business about incorporating in another state is another idea too good to be true.

The Monkey Wrench

Here's the problem. Any state in which you operate your business gets to tax at least some of your business profit. In fact, there is a standard, slightly complicated apportionment formula that accountants and state governments use to determine what share of the business profit each state gets to tax.

You don't need to know precisely how the apportionment formula works. You can leave that to your accountant. But you should know that the formula means that any New Yorker or Californian who operates a business in his or her home state absolutely does not save taxes by incorporating in some other no-tax or low-tax state. (And this general rule is also true for every other state, too.)

Another Minor Problem

By the way, even if you don't care about what the apportionment formula says you owe in business income taxes to the various states in which you operate, you should be aware that you need to register any "out of state" corporation you use to do business in your home state. And, predictably, once you register your out-of-state, or "foreign," corporation in your state of residence, your home state will know about your business and want to tax its profits.

Right Way to Play the Game

If you really want to avoid state income taxes, by the way, the right approach is to attempt to actually move your business or some significant chunk of your business to another no-tax or low-tax state. You will also need to establish residency in that other state to maximize your state income tax savings.

One final comment: Much of the talk you hear about incorporating in another state to save state income taxes is talk by people who don't understand state income taxes and don't know about the multi-state apportionment formula I've made references to here a couple of times. Sorry.

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