You've heard of domestic and foreign LLCs, and you're now wondering what the difference is. Well, we've got you covered. In this guide, we're going to tell you everything you need to know on the subject.
Here's what you'll understand by the end of this article:
- The definitions of a domestic LLC and a foreign LLC
- When an LLC requires foreign qualification and what this means
- How the IRS defines domestic and foreign LLCs
- Where a foreign LLC has to pay tax
- How to work out where to form your LLC
If you're ready to become an expert in domestic and foreign LLCs, let's get started.
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What Is A Domestic LLC?
The term domestic LLC, or Domestic Limited Liability Company, refers to an LLC formed in its home state that will also conduct business within its home state. It's limited to carrying out domestic business in its home state unless it registers to do business in another state.
The term foreign LLC, or Foreign Limited Liability Company, refers to an LLC that has been formed in a certain state but has also registered to do business in a different state. The process of registering a foreign LLC in another state is often known as foreign qualification.
Generally, the terms are not used to differentiate between international and US-based LLCs. Under these terms, both domestic and foreign LLCs are based in the US. In other words, a foreign LLC doesn't operate in a foreign country.
A domestic or foreign LLC is also different from a domestic corporation or a foreign corporation. Domestic and foreign corporations are owned by their shareholders. Domestic and foreign LLCs are owned by one or more individuals.
If you want to form an LLC in the US, you need to file an Articles of Organization in the state where you intend to operate.
When Does An LLC Require Foreign Qualification?
If your LLC regularly conducts business activities in a state other than the one in which it was formed, you must foreign qualify it in that state. This can become complicated, as different states have different rules about what constitutes “conducting business.”
If it's clear that you do or transact business in a state, then you must foreign qualify your LLC in that state. However, if your business entity only has a very limited presence in the state, you may not be required to go through this process.
Unfortunately, these terms are not usually clearly defined by most states. So, it's up to you to assess your business activities in that state and determine if you need to foreign qualify your LLC. We'll take a closer look at this in the next section.
As an example, let's say your Domestic LLC was formed in Texas and you want to register as a Foreign LLC in Georgia. Firstly, you would need to file a Certificate of Authority with the state of Georgia.
Some states also require a Certificate of Good Standing from your home state – Texas, in this example. Georgia doesn't require this, however.
You would also be required to pay filing fees when foreign qualifying your LLC. These fees vary between states and the amount is also based on your business's size and structure.
What Does It Mean To Be Doing Business In A State?
Each state has different rules about what is classed as doing business within the state.
To work out if your LLC would fall under this classification, you need to evaluate the activities of your business. You then need to determine if these activities would constitute transacting business within the state. You also need to consider if these activities would constitute intrastate commerce.
Most states don't define these terms for you. Instead, they define which activities don't constitute transacting business. These activities vary depending on which state you're dealing with.
Most states don't require you to foreign qualify your LLC if your business activities within the state are minimal. These activities usually include:
- Opening a business bank account
- Maintaining a business bank account or other types of bank account
- Making sales through independent contractors
- Creating and securing mortgages and debts
- Soliciting orders for goods as long as the contract must also be accepted outside of the state
As a general rule, if you have an employee in a state, this will trigger the need to foreign qualify your LLC. There is one exception to this rule, however. If the sole function of the employee is to solicit orders that require acceptance outside of the state before they become binding contracts, foreign qualification isn't necessary.
Having customers in a state doesn't necessarily mean you must foreign qualify your LLC. If your activities in the state are limited to those mentioned above, having customers in another state shouldn't trigger foreign qualification.
Domestic Versus Foreign LLC For Federal Tax Purposes
The IRS considers all companies organized in the US and operating under US laws to be domestic businesses. The IRS defines a foreign business as a company organized outside of the US and operating outside its laws.
In a nutshell, a foreign LLC formed in the US would still be classed as a domestic business by the IRS. If an LLC is owned by a non-US resident, the IRS will often refer to it as a foreign-owned LLC. However, foreign-owned LLCs are still classed as domestic businesses by the IRS.
Where Are Foreign LLCs Taxed?
Another difference between domestic and foreign LLC formation is where they pay taxes. Foreign LLCs must pay their taxes in the state where they're registered as a foreign entity. Unless the state has no income tax, foreign LLCs must also pay state income tax.
So, a foreign entity operates in a second state, but must also pay state income taxes in its home state. Domestic and foreign LLCs must also both pay federal income taxes.
Where Should I Form My LLC?
When forming a domestic LLC, perhaps the most important decision is which state you're going to form it in. If you have a small business, then it usually makes the most sense to form your LLC in your home state. This is because small businesses are less likely to operate in multiple states than bigger businesses.
If your LLC is only registered in one state, then it reduces the administrative duties, complexity, and cost of forming it.
However, there are benefits to forming a domestic LLC in a state that isn't your home state. By doing so, you can take advantage of favorable legal precedents and business-friendly rules in a certain state.
Let's say your business has owners in various states and will operate in multiple states. In this case, you should form it as a domestic LLC in your home state and register it as a foreign LLC in the other states you will operate in.
Many LLCs choose to form an LLC in Delaware and Nevada. This is because there are no state income taxes or franchise taxes on LLCs in these states. The managers and owners (members) of an LLC don't need to be residents of these states to receive these tax breaks.
However, doing so may not be worth the effort. If you are required to foreign qualify in a different state to do business there, you will likely end up paying income taxes in that state anyway. Meanwhile, you would still have to deal with the administrative hassle of operating in two states.
Things to consider when choosing a state for your LLC
- Tax obligations and incentives.
- To what degree assets are protected in the state.
- The filings and fees that are required, such as annual reports, initial filings, and other information reports.
- Management simplicity and flexibility. More requirements are imposed by some states than others.
Frequently Asked Questions
What is the main benefit of foreign LLCs?
The main benefit of foreign LLCs is that they allow you to operate in multiple states without forming separate LLCs in each of the states. This is ideal if you're planning to expand your business into other states in the future.
Do domestic and foreign LLCs protect you from personal liability?
Yes, both domestic and foreign LLCs protect you from personal liability for the debts of your business. The LLC itself is responsible for the liabilities and debts incurred by the business. The managers and owners are not liable.
Can non-US residents form domestic and foreign LLCs?
Yes, you don't need to be a US resident to form a domestic or foreign LLC in the States. A non-US resident can also form a domestic or foreign corporation. However, a non-US resident is unable to form an S corporation.