Forming an LLC in California

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They say California is the Land of Milk and Honey and the Sunshine State, but it’s also the land of sky-high fees and taxes! Yes, the taxes you pay to form a California LLC stay in California, but the high cost of doing business as an LLC in the state causes many businesses to consider other options - like forming the LLC in the LLC-friendly State of Wyoming.

Empty Your Wallet to Start an LLC in California

California’s notoriously high tax rates make it a no-brainer to look elsewhere to form an LLC. In addition to exorbitant taxes, California charges a high registration fee to form an LLC, as well as an $800 franchise tax. Many aspiring entrepreneurs think they won’t be subject to the franchise tax because they are not starting a “franchise,” but the franchise tax applies to all LLCs formed in California and all LLCs formed in other states that are “doing business” in California.

While you may not think your out of state LLC is “doing business” in California, it is very likely that California will disagree! California now has what many people feel is an excessively broad definition of what “doing business” in their state means. In terms of California’s definition of “doing business”, the new rule is as follows:

If an out of state LLC has a managing member who is a California resident, the out of state LLC is treated as “doing business” in California and therefore must pay the state their $800 annual fee. This is true even if the LLC generates no money in the state of California or from any California sources. If a member is a California resident and the LLC issues a K1 to the resident, it is likely the LLC will receive a demand for payment of the $800 fee from California. If the LLC owns real estate or other property in California worth more than a certain amount, even if the LLC has no managing members who are California residents and collects no income from California sources, California will treat the LLC as “doing business” in California and demand the $800 annual fee!

What If I Ignore the California
Rules and Don’t Pay the $800?

California imposes draconian penalties for failing to qualify an out of state entity in California by registering it as a foreign entity and paying the $800 annual fee. The penalties include:

  • A penalty of $2,000, in addition to other failure to file penalties;
  • The inability to bring a lawsuit in California;
  • A penalty of $20 a day up to $10,000 for failing to file California tax returns; and
  • The treatment of all members as general partners and thus imposing unlimited personal liability for all acts committed in California.

If I Can’t Avoid the $800 Tax, Why Not Just Form an LLC in California?

The sad reality is that a California LLC does not provide much asset protection because the state has weak LLC laws, particularly for single member LLCs. Unlike Wyoming, a charging order is not the exclusive remedy of a California LLC member’s personal creditor, it is just one of the remedies available. In fact, California may let your personal creditor foreclose on your interest in a multi-member LLC and sell it in a foreclosure sale! This would be a terrible result for you and your partners.

Forming your LLC in Wyoming and then registering it in California (yes, that means paying the $800 fee), should mean that the laws of Wyoming should be applied to the LLC, where a charging order is the sole remedy of an LLC member’s personal creditor. This could stop a member’s personal creditor from causing harm to the LLC, your partners, and you.

While there is no guarantee that California courts will always apply the law of the state where you formed your LLC instead of the less favorable California LLC law, it will at the very least give you a great argument to make and bring your personal creditor to the negotiating table!

Why Wyoming is a
Popular State to Form an LLC

Back in 1977, Wyoming became the first state to recognize limited liability companies. Since then, the state has imposed a limited number of regulations that the Wyoming Limited Liability Company Act governs. The limited number of regulations is just one reason why entrepreneurs flock to the state to start an LLC.

Easier to Form an LLC in Wyoming

California is the king in the United States for generating governmental red tape. The articles of organization required to form an LLC in California read about as long as a standard novel. Wyoming requires LLCs to submit just five pieces of information to get their business visions off the ground in the state.

  • Business name
  • Business mailing address
  • Street address of the primary office
  • Name of registered agent
  • The mailing address of the registered agent

Wyoming also does not require the members of an LLC to submit a written operating agreement. The timeless principle of a few handshakes cements the terms of operating an LLC in the state.

Learn more about why the State of Wyoming stands out as the best place to form an LLC in the United States by contacting the Cloud Peak Law Group.

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