Forming Your LLC in Nevada:
Does It Really Work?
by Stephen L.
Nelson, CPA
If you've done much web research about setting up a limited liability
company, or LLC, you've seen the advertisements that tout Nevada. The pitch is
pretty simple. Because Nevada doesn't levy an income tax on individuals or
corporations, you should form your LLC in Nevada. The implied promise is that
you'll save big on state income taxes.
Okay. Don't get me wrong. I like saving income taxes as much as the next tax
accountant. But the Nevada LLC formation question is trickier than most new
entrepreneurs seem to understand.
Unless all of your business activity is in Nevada-and it probably isn't
unless you're a Nevada resident operating a business in Nevada-you'll need to
apportion your business income among the states where you operate.
This apportionment amounts to a three-step process as outlined in the
paragraphs that follow. To make the steps concrete, let's assume that your
business makes $300,000 a year.
Step #1: Apportion One-third Based on Payroll
One third of your income gets apportioned to the states where you operate
based on payroll. In other words, if your business does make $300,000 a year,
$100,000 of the profit is apportioned, or assigned, to states based on the
payroll expenses that your business incurs.
If your payroll is split evenly between California and Arizona, this would
mean that $50,000 of your profit would be apportioned to California and another
$50,000 would be apportioned to Arizona entirely on the basis of payroll.
Notice that no profit has been assigned to Nevada.
Step #2: Apportion One-third Based on Property
Another one-third of your income--$100,000 in our example-gets apportioned
to the states where you operate based on the property you own in those states.
Some complications exist when you talk about property. In many states,
perhaps most states, rented or leased property factors into the equation based
on goofy little formulas.
But to return to our example of the Nevada LLC, suppose that the LLC only
owned property in Washington state. In this case, then, $100,000 of the LLC's
business profit gets assigned to Washington.
Er, not to beat a dead horse, but do you notice how none of the Nevada LLC's
profit has been assigned to Nevada yet?
Step #3: Apportion One-third Based on Sales
The final one third of your income, that last $100,000 of profit, gets
apportioned to the states where you sell your stuff. This "state of sale" stuff
can get real complicated. States and taxpayers frequently argue about where a
sale occurs based on things like the seller's location, the buyer's location, or
where title transfers.
But let's not dig deeply into that detail. Let's just assume that your firm's
sales are evenly split between five states: California, Oregon, Washington,
Arizona, and Nevada.
In that case, the $100,000 of profit allocated based on sales is evenly split
among the five states, with $20,000 going to each of the five states. That of
course means that only $20,000 of the profit gets allocated to Nevada.
The Reality Sandwich
Suffice to say, the business owner who runs his business as a Nevada LLC or
corporation may not get the tax effect that he or she wants.
With the example numbers used in this little article, only a small portion of
the profit gets allocated to Nevada and, thereby, escapes taxation.
Which brings to mind the old cliché: If something seems too good to be true,
it sometimes is too good to be true.
New York LLC formations expert and tax accountant Stephen L. Nelson CPA has
written more than 150 books. Formerly an adjunct tax professor at Golden Gate
University, Nelson is also the author of QuickBooks for Dummies.
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