By J. Keith Phifer, Esq.
There was a time in the not so distant past when most small to medium sized businesses conducted all of their activities within the confines of their home state. Unless a business was located near state borders, businesses did not need to concern themselves with the effects of incorporating in one state, while conducting business in another.
This is no longer the case. With the advent of the internet, faster and more reliable shipping services, shortened travel times, and the general movement toward a smaller, better connected, and easily accessible world, even the smallest of businesses have the ability to reach across the country and beyond.
While this increased ability to expand and reach farther than ever before is generally advantageous to businesses because it provides access to more potential customers, it does not come without potential pitfalls. One such potential issue is failing to file as a foreign corporation in each state (other than the state of incorporation) in which the business operates. While a corporation may have been incorporated in Massachusetts (i.e. its articles of organization were filed with the Massachusetts Secretary of State), and thereby has access to the Massachusetts state court system, such a corporation must also protect its interests in foreign states where it conducts business. In order to do so, it should qualify in each state where it does business by filing as a qualified foreign corporation with that state's Department of Corporations. This is as opposed to filing a tax return with the state department of revenue, which is the taxing entity. The two are distinct state agencies with different rules.
Failing to qualify in foreign states has significant consequences. In every state, failing to qualify will prevent an unqualified foreign business from bringing or maintaining an action in the courts of that state. In practical terms, this means that a business that enters into a contract in a foreign state is unable to enforce that contract in the state. A Massachusetts entity, therefore, will not be able to enforce a contract that it entered into in Rhode Island. Furthermore, the claim would be barred in federal court as well if the federal claim is based on diversity of citizenship, meaning that the parties were not from the same state. The issue of qualification also often manifests itself when a business enters into a sale or refinancing in which a bank or buyer will likely require the business to represent that is it qualified in every state in which it conducts business. In addition, many states impose significant fines on businesses that conduct activity in the state without having qualified. These fines vary from state to state. In some cases, they are quite large. Maine, for example, imposes a fine of $25 per day. In Massachusetts, the fine is limited to $500 per year. Other states impose fines of up to $10,000.
However, the process of qualification is complicated by the fact that each state has its own rules for determining how much activity constitutes 'doing business' in the state, thereby necessitating that the foreign corporation qualify. Furthermore, the test is different for purposes of determining whether a corporation is required to file taxes in a given state. Although your CPA may correctly advise you that you are not required to file income taxes in a given state, you still need to determine whether you must file with the department of corporations in that state. In Massachusetts, the rule is that every foreign corporation which does business in the Commonwealth shall be considered to be doing business in the Commonwealth for the purposes of filing as a foreign business unless its activities within the Commonwealth consist of no more than maintaining bank accounts, holding a meeting, or such similar negligible relationships with the Commonwealth.
The crux of the provision is that if you are a foreign business, (i.e. incorporated in another state) and you are engaging in anything more than the above in Massachusetts, it is likely that you are doing business in Massachusetts, and you should qualify as such. Of course, this example is for discussion purposes, and the same holds true for Massachusetts corporations doing business in any other states. If your business has been conducting activities in a state for which it has not qualified, states have various rules regarding retroactive qualification, but most states will allow you to do so after fees and penalties are paid.
Small distinctions between a foreign corporation's activities in a given state may make a world of difference for both qualification and tax purposes. For example, a foreign corporation that maintains an agent in the Commonwealth who advertises and solicits customers in the Commonwealth would likely be subject to Massachusetts taxation if that agent maintains an office in the Commonwealth, whether such office is leased or owned by the corporation. But if such agent does not maintain an office, then the corporation likely will not be subject to taxation, so long as sales for the corporation are fulfilled outside of the state. However, in both cases, it is likely that the foreign corporation will be deemed to have conducted business in Massachusetts for purposes of the Commonwealth's qualification statute whether the agent maintains an office in the state or not.
Although each state's rules are different, the general concept is true of all states. If you conduct business in the state, you should file for qualification.
The filing fee for qualification in Massachusetts is currently $400 for corporations and $500 for LLC's. However, Massachusetts is generally among the most expensive states for qualification purposes, and in some states the fee can be as inexpensive as $50. As each state has different rules for what is and what is not doing business, each state also has different requirements for the qualification process. Most states require that a business supply a certificate of good standing from its home state of incorporation, and some have unique requirements, such as Arizona, which requires a business to publish a notice in a widely circulated newspaper in Arizona.
Every state requires that you name an agent for service of process in that state, and there are many companies that will act as such in each state for a small fee if the corporation does not maintain an office in the state. Some states require very little financial information about the business, and some require specific information about the company in order to establish how much business will take place there.
Growing businesses should be cognizant of these issues, and should take the opportunity to plan for them. Take an inventory of the states in which your business conducts activities. Prudent planning today will prevent problems down the road and keep expenses to your business at a minimum.
If you have any questions, please contact us.