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Editorial 9 MIN READ

How to choose a state when you don't live there, 2019

The Wyoming-shell pitch was always shaky on foreign-qualification grounds. After Wayfair it is weaker still, because the sales-tax map now follows the customer, not the charter

The Editors
Staff, Incorporator.org
9 min read Updated
Contents 7 sections
  1. What Wayfair changed about the choose-a-state question
  2. The 2016 baseline, updated
  3. Where the new penalty kicks in
  4. The remaining honest use cases for a non-home state
  5. How the pitch reads in 2019
  6. Rule of thumb
  7. Sources

leven months after South Dakota v. Wayfair and thirty months after we first worked through the choose-a-state question on this site, the right answer has not changed: form where you operate. What has changed is the size of the penalty for getting it wrong.

In December 2016 the cost of forming a Wyoming LLC and operating it from California was roughly $160 a year of pure waste on top of California's $800 franchise tax. In May 2019 that same decision can layer on sales-tax registrations in a dozen or more states, because the chartering state no longer determines where the seller has to collect. The customer's state does.

What Wayfair changed about the choose-a-state question

South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018), overruled the physical-presence rule of Quill Corp. v. North Dakota, 504 U.S. 298 (1992), and substituted an economic-nexus standard. A remote seller that meets a state's dollar or transaction threshold, usually some variant of $100,000 in sales or 200 separate transactions into the state per year, must register, collect, and remit that state's sales tax. We walked through the statute-by-statute landscape in Economic nexus after Wayfair the month the opinion came down. In the year since, the picture has filled in fast. As of May 2019, forty-one of the forty-five states with a general sales tax have either a statute or an announced administrative rule on economic nexus, and the remaining holdouts have bills in committee.

This matters for the choose-a-state question because the old intuition that a Wyoming charter would somehow carry its Wyoming treatment out into the world was always wrong, but for most of that time the only state whose cost you could not dodge was your operating state. The other forty-nine stayed out of it unless you had a warehouse or a sales rep there. After Wayfair, any state where you ship enough has a direct revenue claim on you. The shell state is still irrelevant to that analysis.

So the old bad trade, form in Wyoming to operate in California, still loses to forming in California on the income-tax and foreign-qualification math. It just now loses by more, because the sales-tax headache you take on as an e-commerce seller is identical whether your charter reads Cheyenne or San Jose.

The 2016 baseline, updated

The arithmetic from our 2016 walk-through still works with minor updates. A California resident who forms a Wyoming LLC and operates the business from home pays:

Wyoming, on formation, $100 for Articles of Organization with the Wyoming Secretary of State.

Wyoming, annually, a $60 minimum license tax under Wyo. Stat. § 17-29-209, which pegs the tax at "sixty dollars ($60.00) or two-tenths of one mill on the dollar ($.0002)" of the LLC's Wyoming-situs assets, whichever is greater. Plus a commercial registered-agent fee inside Wyoming, which in 2019 runs roughly $50 to $200 a year at the competitive end of the market.

California, annually, an $800 minimum franchise tax under Cal. Rev. & Tax. Code § 17941 on every LLC "doing business" in California or registered to do so. "Doing business" is defined at R&TC § 23101 as actively engaging in a transaction for profit in California, or exceeding any of three indexed quantitative thresholds, for 2019 tax years approximately $601,967 in California sales, $60,197 in California property, or $60,197 in California compensation. A consultant working from a California apartment meets the first prong on its face.

Because the Wyoming LLC is transacting intrastate business in California, Cal. Corp. Code § 17708.02 requires it to register as a foreign LLC before it can do so. The filing is Form LLC-5, $70. An LLC that transacts intrastate business in California without registering cannot maintain an action in California courts until it registers (Cal. Corp. Code § 17708.07), and the Franchise Tax Board has authority to assess the $800 plus penalties and interest retroactively.

Net annual cost of the Wyoming detour: roughly $160 plus the cost of running two sets of books. Net benefit for an operating business headquartered in California: none.

Where the new penalty kicks in

Take the same California resident and change the business to something that ships: a Shopify store selling housewares nationally, run from the same Oakland kitchen table. Pre-Wayfair, the choose-a-state analysis collapses to California plus a shell-state vanity premium. Post-Wayfair, it grows a second dimension.

South Dakota's safe-harbor thresholds, blessed in Wayfair and codified at S.D. Codified Laws § 10-64-2, are $100,000 in gross sales or 200 separate transactions per year. That pattern has been copied, with deviations, by most states. A sample as of May 2019:

California, under AB 147 signed April 25, 2019, sets a $500,000 threshold with no transaction count and requires collection beginning April 1, 2019 (retroactive enforcement forgiven). Cal. Rev. & Tax. Code § 6203, as amended by AB 147.

Texas Comptroller Rule § 3.286, adopted December 2018 and effective October 1, 2019, imposes a $500,000 threshold on remote sellers.

New York enforces under Tax Law § 1101(b)(8)(iv) as amended, requiring remote-seller collection at $300,000 and 100 transactions, conjunctive, based on Department of Taxation and Finance guidance issued January 2019 following N-19-1.

Pennsylvania, under Act 13 of 2019, moves from its pre-Wayfair notice-and-report hybrid to a straight $100,000 economic-nexus rule effective July 1, 2019.

Illinois, under Public Act 100-0587, sets $100,000 or 200 transactions, effective October 1, 2018.

Washington, under the 2019 amendments to RCW 82.08.052, sets $100,000 in retail sales and removes the old 200-transaction alternative, effective March 14, 2019.

New Jersey, Georgia, Indiana, Kentucky, Iowa, Michigan, North Dakota, Utah, Vermont, Wisconsin, and about a dozen other states sit at or near the $100,000 / 200 transaction line with effective dates already past.

A seller hitting the median threshold in each of these states registers, collects the destination rate, remits on that state's calendar, and tracks the threshold year over year. None of that obligation depends on the formation state. A California LLC, a Wyoming LLC, a Delaware LLC, and a New Mexico LLC operating the same Shopify store face identical sales-tax obligations once the thresholds are tripped. Forming in Wyoming to save $740 on the California $800 saves nothing when the price of admission to the eleven to twenty states that get crossed first is a registration, a filing calendar, and a sales-tax-compliance subscription.

The remaining honest use cases for a non-home state

The three exceptions from 2016 are still the exceptions in 2019.

Venture-bound C-corporations should form in Delaware. Institutional investors expect it and will require a conversion later if the company starts elsewhere. The Delaware annual cost, $300 LLC tax under 6 Del. C. § 18-1107 or $450-and-up corporate franchise tax plus $50 annual report under 8 Del. C. § 503, is a rounding error compared with the legal fees of a Delaware flip. We walked through the flip mechanics in How to time a Delaware flip last summer.

Holding entities for passive assets (real estate held for rent or appreciation, intellectual property licensed to an operating sibling, a brokerage account) can rationally sit in Wyoming or New Mexico. A pure holding LLC is not "doing business" in the conventional sense anywhere; Wyoming's $60 or New Mexico's actual zero (the New Mexico Secretary of State does not require an annual report for domestic LLCs at all) is the lowest maintenance cost in the country. The operating company that deals with the public is a separate entity formed at home. Two entities, two jurisdictions, two annual obligations, and a clean paper trail on why each one exists.

Privacy-motivated formations in Wyoming or New Mexico still work for the original reason: member names do not have to be on the public filing. That is a real feature if you are buying rental property you don't want tied to your name by a county-recorder search. It is not a tax play, and it does not change the foreign-qualification posture.

Everything else, the one-person consultancies, the Etsy stores, the rental side-gigs operated from the owner's garage, forms at home. The market for "Wyoming LLC formation, no state income tax" packages is not exactly fraudulent, but it is selling a feature that does not attach to the customer's actual business.

How the pitch reads in 2019

The incorporation-services industry has not retired the Wyoming pitch. The marketing copy has adjusted at the margins. Where 2016 ads sold Wyoming as a tax dodge, 2019 ads tend to sell Wyoming as a privacy tool, which is a narrower and more defensible claim. Read a Wyoming package carefully and you will usually find language that, on close inspection, makes no tax claim at all. The seller has learned.

What has not changed is the buyer's instinct that somehow the formation state is load-bearing. It almost never is, and after Wayfair it is less load-bearing than it has ever been. The three things that matter for an operating business are the state where the work happens (income tax and franchise tax), the states where the customers are (sales tax, post-Wayfair), and the owners' home states (personal income tax on distributions). None of those three is the formation state, unless the owner happens to live and work there.

For the marginal case, an LLC forming in May 2019 with a single member who lives in, say, Idaho and sells digital products nationally, the calculus is: Idaho charges $100 to form and $0 for an annual report, Wyoming charges $100 and $60, and the Idaho filing gets the owner one less set of foreign-qualification paperwork. Form in Idaho. Ship the same product. When the Wayfair thresholds start tripping, the state-list is identical either way.

Rule of thumb

Form where you live and work. Use a second state only when a specific feature of that state's law, Chancery precedent for a venture round, member-privacy for a holding entity, or the ability to hold passive assets at a lower annual cost, is the reason you are forming in the first place. If the only advertised reason is "no state income tax" or "lower annual fees," the advertised reason does not survive contact with your operating state's franchise-tax rules, and after Wayfair it does not survive contact with the sales-tax map either.

The Wyoming-is-cheaper pitch worked, when it worked, on an intuition that the chartering state controlled the exposure. It never did entirely, and what residual truth it held has been eroded twice in three years, first by vigorous state foreign-qualification enforcement and now by the collapse of physical presence as a sales-tax floor. What survives of the pitch is a genuine but narrow privacy feature and a genuine but narrow holding-company play. Everything else is a service sold to a buyer who would be better off filing at home.

Sources

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