Many businesses have been flocking to Delaware for incorporation, enjoying one of the best tax and legal environments.
Benefits of starting a business in Delaware are obvious; however, business owners may wish to expand to different states for new opportunities. This leads to a million-dollar question: How can Delaware companies be able to do business outside of Delaware?
In this article, we’ll walk you through the basis of Delaware’s foreign qualification – an entrance ticket for businesses to enter different states in the US.
1. What is a foreign qualification?
Foreign qualification is the process of asking for permission to conduct business activities in states other than the one in which the business is registered and formed. To be qualified for business operation in other states, Delaware companies must apply for a Certificate of Authority, or a Statement & Designation, via the Secretary of State’s office of these states.
A Delaware company will be classified as a foreign entity in that other state when doing business in states outside Delaware. It depends on certain situations to determine whether your Delaware business must meet the foreign qualification requirements. In some states, a certificate of good standing from the home state may be required for Delaware companies.
2. Who needs to file a Delaware foreign qualification?
A Delaware company wishing to do business in another state is normally required to obtain foreign qualifications
A Delaware company must foreign qualify in other states if it is engaged in intrastate business. But if it is engaged in interstate business, the company doesn’t have to qualify. Let’s see what is the difference between these types of businesses:
Intrastate business. Your Delaware business is considered an intrastate business to other states when at least one part of the company is completely conducted in these states. In this case, your company must meet foreign qualification requirements.
For example, when your Delaware company sells the products from its warehouse in another state to customers within that state, your company is conducting intrastate business. Therefore, you are required to obtain a Certificate of Authority by that state.
Interstate business. When your Delaware company conducts business between states, your business is treated as an interstate business. For instance, your Delaware business provides goods and services for customers in other states. In this case, your company doesn’t have to meet foreign qualifications.
There are exceptions to intrastate requirements. For Delaware companies which are foreign companies in other states, certain types of activities of an intrastate business will be exempted from foreign qualification, including:
- Mail order or telephone sales, if they are the only activity of the company conducted in the state;
- Website maintenance, if it is the only proof of your presence in the state;
- National (not local) advertising campaigns to customers in the state;
- Sales are carried out through independent contractors in the state.
3. Why does foreign qualification matter?
It is compulsory for out-of-state companies to do foreign registration for their legal operation in states where the business is transacted. A Delaware company that wants to do business in another state must ask for permission from that state.
Foreign qualifying helps the government to manage the tax revenue of the foreign business entities. In return, the companies can get the privilege of conducting business there, exploring more potential business opportunities for their company.
The registration of foreign entities also improves business transparency by allowing the public to access their basic information such as legal name, registered agent’s name, and address.
Still, by registering as a foreign company, the Delaware company is subject to the tax and reporting requirements regulated by other states for the privilege of business conduction there. In this way, the foreign entities will perform legal and tax obligations fairly compared to domestic business entities.
Failing to meet the foreign qualification requirements will result in:
- Fines and penalties for conducting business without foreign registration,
- Liability for back taxes for transacting business while not foreign qualified,
- Inability to access the court system in the state for any business petition.
4. What documents are required for foreign qualification?
The requirements, procedures, and costs for foreign qualifications will vary depending on each state.
Below are common docs required for the foreign qualification process by most states in the US:
- Certificate of Good Standing
- Certified copy of Certificate of Incorporation or Certificate of Formation
There are five basic steps for obtaining the Certificate of Authority:
Step 1: Check if your desired business name is available in the record of the Secretary of the state where your business is performed
When you enter a business in a state, it is required for your company to have a unique legal name for business operation. You can always reserve your business name to avoid being taken away by other companies.
Step 2: Appoint a registered agent in the state
The registered agent is the intermediary who works on behalf of your company to receive legal papers and notices from the state. The agent can be an individual or a business entity. Your company acts as a registered agent if it maintains a physical address in the state.
Step 3: Order the Certificate of Good Standing from Delaware
Not all states require the certificate. You don’t have to get it unless the state where your business is transacted doesn’t ask for the submission.
There are some Delaware companies that fail to maintain good standing status for complying with the state’s obligations. In this case, it is important to complete all the obligated filing and apply for the certificate.
Step 4: File the foreign qualification documents
Filing Certificate of Authority requires an Incorporation Certificate (or Formation Certificate) and a Good Standing Certificate (if applicable).
There is some required information for the foreign qualification process for Delaware companies, which is listed below. But additional information may be required depending on each state’s requirement.
- Company name and address
- Name of managing member or officer who will be responsible for signing the documents
- Registered Agent address
- Business nature and scope
Step 5: Submit annual filings
Each state will have different annual maintenance requirements with associated fees for a foreign business entity such as franchise tax, annual report filing, annual tax, etc. Failing to these submissions may lead to the discontinuance of business operations in the state.
Costs and processing time for the foreign qualification process will be different depending on the state of doing business and the type of business entity. The average cost will be around $230 for a Delaware corporation and $190 for an LLC.
5. What are common tax compliances as a foreign entity?
- Franchise tax
Paying the franchise tax is to ensure the privilege of conducting business in a state other than the home state. There are 13 states that apply franchise tax for foreign business entities, which are Alabama, Arkansas, California, Delaware, Georgia, Illinois, Louisiana, Mississippi, New York, North Carolina, Oklahoma, Tennessee, and Texas.
- State income tax
Most US states require foreign business entities to pay state income tax. The tax is levied directly on the revenue generated in the states by the company.
- Economic nexus (Sales tax)
Economic nexus is the connection between the income produced by the out-of-state companies and the states where business is transacted. Each state will have a different threshold for the income to determine whether or not the company has the nexus in the state. When the company earns above the revenue threshold, it must collect sales tax for activities performed in the state.
- Payroll tax
It is the amount of tax withheld from the employees’ salaries and wages. The tax is only imposed on the company which hires and manages employees in states of business operations, and it is collected from foreign companies by the government.
Failing to file tax obligations will result in substantial tax assessments and penalties for foreign business entities.
As a Delaware company planning to do business across other US states, it is important to understand if your business must meet the foreign qualification. Each foreign qualification comes with a different filing fee, annual fee, and legal compliance.
Any non-compliance regarding the process of foreign qualification could cost your business a lot more money, time, and effort. It is advisable for you to consult the professionals regarding the matter.