Legal Question in Business Law in California

Forming LLC in home state or where client is
I am currently employed full-time, but thinking about doing some consulting on the side. A company in Washington state would be my first client and they would likely be my only client for the foreseeable future. I live in California and I am considering forming an LLC, but the problem I am faced with is the $800 franchise tax in California. Since I am doing this work on the side, I wouldn't expect my revenue to be very significant, so $800 represents a large percentage of revenue. Additionally, since I am already employed full-time, all of the income from the LLC would be taxed at my marginal rate. As a result, I have been trying to decide if it makes any sense to form the LLC in Washington. I know that California does everything it can to prove that I am doing business their, but is it possible to argue otherwise and have firm ground to stand on? Assuming I kept this company as my only client, would the fact that I am physically located in California be the overriding factor? I would be more than willing to open my company�s bank account in Washington and I have a physical address that could be used there as well. I'm just not sure if this is enough support to form in Washington or if I should just do it in California.

Asked on 11/11/08, 3:21 pm

2 Answers from Attorneys

Erik Nowacki Business Law Inc.

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Re: Forming LLC in home state or where client is

The State of California is getting very aggressive in collecting fees and taxes. Recently, they enacted a rule that any LLC with a California resident as a manager must qualify to do business in CA. Once you qualify in California, you will be subject to the $800 minimum franchise tax.

If you form the LLC in Washington, the FTB is likely to find out about the Company through your personal tax return. The LLC would issue you a Form K-1 (similar to a 1099) for your share of the Company's profits. You disclose the K-1 information on your personal 1040, which you send to the CA Franchise Tax Board.

Therefore, it is probably a safer bet to form the LLC in California from the start.

Another alternative would be to form a C-corp in Washington. This would solve some of your issues, but it would create a different tax situation to be discussed with your CPA/Accountant/Tax Advisor.

The C-corp can retain some of the profits, to avoid paying personal income taxes on the profits. A C-corp would also be more difficult for the State of California to trace back to California and you in particular. It would also be very difficult for the State of California to trace the amount of work performed by the Company within CA. However, if you are performing services within CA, you are supposed to qualify the entity in CA.

Disclaimer: This is not to be taken as legal advise in any particular situation. There are many factors that determine the optimal entity to use and requires a thorough discussion of all pertinent facts. The facts provided in this particular instance are insufficient to determine the best entity for your particular situation.

Answered on 11/11/08, 7:25 pm

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