Tax Havens For Online Businesses
by Jennifer Reuting
If your website or business does not operate out of a corporation or LLC, you’ve probably given some thought at one time or another as to whether there is any benefit to you or your business to have one. Online businesses are different from traditional businesses in many ways that make them especially good candidates for operating out of a formal business entity.
One of the great benefits of incorporating is that you create legal separation between you and your business. In other words, your business is its own legal entity. It has its own bank account, pays its own taxes and, most importantly, has the option of “living” in whichever state (or country) you decide. Why then, do so many business owners limit themselves by forming corporations in their home state? Unless you are one of the lucky few that happen to live in a tax haven such as Nevada or Wyoming, take into consideration whether or not your state is the best tax climate for your company.
However, while businesses can “live” in whichever state they desire (technically called “domiciled”), they still have to register and pay taxes in each state where they transact business. And while each state has a different idea of what that term means, for the most part, if you have employees or office space in a particular state, you are transacting business there.
Qualifying Online Businesses and Tax Havens
If you operate a pure online business chances are your company only exists in a virtual world. If you don't keep office space and instead of employees you have independent contractors — such as programmers and server administrators, who are often in developing countries — you are a perfect candidate for saving on taxes via a tax haven.
Tax havens are generally states that are very pro-business and tax-free — no corporate taxes, franchise taxes or personal income taxes. There are two major tax havens in the United States — Nevada and Wyoming. The only significant difference between the two is that Wyoming seems to offer lower fees and doesn’t carry the tax haven stigma that Nevada has developed over the years.
If you have a truly virtual online business, all you have to do is form a Nevada or Wyoming corporation. Keep in mind that it can’t be an LLC unless you elect corporate taxation with the IRS. Otherwise, all of your income will pass through to your individual tax return in the state in which you live. This means that you will have to pay state taxes on the income at an individual level as if it were income to yourself.
When forming your corporation, it’s recommended to use a professional service. If you choose to go it alone, you may have to spend many more hours than you realize to understand the filing procedures and the nuances of that particular state — all from hundreds of miles away. A better bet is to use a national company with associates who specialize in each state and not only know the required filings, but also maintain strong relationships with state employees — an important factor to getting things filed in a timely manner.
Keep in mind that as soon as you issue yourself payroll, your corporation or LLC will need to register to transact business in your state — which means it will have to pay taxes from all income derived in that state. Therefore, you should try to take money out of your company in the form of loans and dividends.
There have been exceptions to the rules of late...
The City of Chicago is suing StubHub.com and eBay, Inc. in an attempt to collect an amusement tax from event tickets sold online. The City of Atlanta is suing 17 online travel companies claiming they owe the city millions in unpaid room taxes. New York unleashed the worst of all when they recently passed legislation that requires online businesses to collect and pay sales taxes. There are numerous challenges to these laws that are pending. Amazon.com doesn’t like the idea of collecting and paying sales tax in a state in which it has no presence, and laws like these conflict with the “commerce clause” that prevents states from interfering with interstate commerce. The Supreme Court has already weighed in when they decided that retailers could not be compelled to collect sales and use taxes unless they had a “substantial physical presence” in the state, so it will be interesting to see how this fight turns out.
Should you form your entity yourself, then you will need to find a qualified registered agent. Since you will not be “living” in the same state as your LLC, it is imperative that you find a registered agent whom you trust to keep you updated on required filings and to make sure your company stays in good standing with the Secretary of State. Also — this is important — you need to make sure your registered agent allows you to use their address as your business address. If possible, you will want to use this address for everything you can in relation to your business. This means that someone will need to be present during normal business hours each day and will forward your mail to you on a daily basis. I always recommend either one of the “Big Four” national registered agents (CT, InCorp, CSC, or NRAI), or an attorney in whichever state you decide to incorporate.
Once you have formed your corporation in your tax haven state, you need to open a bank account in that state. It is imperative that your bank account has a routing number associated with your tax haven. Don’t make the mistake of opening an account in New Mexico if you are trying to establish that the company is legitimately operating out of Nevada or Wyoming. You have to look at this as a complete separation of yourself and your business. You need to operate your company out of the state in which it is domiciled.
Prior to September 11, 2001, it was common to utilize off-shore tax havens, such as the Cayman Islands and the Isle of Man. Contrary to popular belief, off-shore tax havens can serve legitimate purposes, especially the protection of assets. However, the government has subjected these off-shore companies to intense scrutiny and their slogan has now become “guilty until proven innocent.” Since you can often achieve your same goals within the borders of the United States, I don’t recommend utilizing off-shore corporations, even for the most legitimate of reasons.
What’s the Catch?
Does this all sound too good to be true? It’s not, for the most part. There is one small snag to look out for. Some states automatically consider the President, Secretary, and/or Treasurer whom you elect to be employees of the company. This means that if you intend on being an officer of your company, you will need to register and pay taxes in the state in which you live. As stated previously, keeping employees in that state is considered “transacting business” there.
There are very few states that will vigorously enforce this rule, but New York and California have been known to be pretty tough. However, there are ways around this. If you have another company, such as an LLC or another corporation, you can list that as the “officers” of your company or you can hire a contract officer which is a person that holds no power in your company but takes care of corporate formalities for you such as drafting and enacting minutes and resolutions. More importantly, a contract officer affords you privacy since their name is on public record as the officer and director of your corporation. In either of these cases, you would title yourself as something vague such as CEO or Founder — titles that do not need to be listed on public record.
In the event that your corporation or LLC is required to file to transact business in any other state, including your home state, remember that this does not have to be as bad as it sounds. As long as your corporation is domiciled in a tax haven, you will most likely only have to pay state taxes on the income that was derived from within that state. That still leaves income from the other 49 states that will be state tax free. Just be sure to seek a qualified tax professional in your home state to ensure that your state isn't the exception to the rule!
About the Author: Jennifer Reuting is the author of Limited Liability Companies for Dummies and Founder of MyLLC.com, a leading document filing service that caters to individuals and small business. She is also the Founder of CutiesForCanines.org, a non-profit organization that rescues shelter animals.