The Nevada Myth

Nevada myth and other states where “corporate law is better”

There is often a question that clients pose about whether they should form a “Nevada corporation” or form their entity in some other state.  Obviously, state law “matters” in corporate law.  Most public entities choose to incorporate in Delaware.  Nevada is a popular jurisdiction for public and private entities.  However, the reasons that people believe that Nevada is “better” are not necessarily the right reasons.  An analysis of “which state” is really a discussion about the kind of liabilities that arise in business, and whether it does your particular business any good to avail yourself of a particular forum.

Different states have different laws.  Laws arise in two primary expressions: cases and statutes.  Each case has the ability to create statutes by legislation, and each state can create statutes that are unique to that state. Thus, each state creates its own, unique business law.  The business law of the state will dictate whether a corporation can amend its bylaws with only a majority of the shareholders voting.  The business statutes of the state will determine what rights a shareholder may have if the company is mismanaged by an officer, or if the major shareholders prevent the minority shareholder from sharing in company profit.  Many other corporate issues are addressed by each state’s specific statutory law.

Each state has its own judicial system as well.  Judges are charged with interpreting and applying the statutes, and following non-statutory “principles” known as “common law.”  The decisions of courts that are published become law known as “case law” which can be used to set “precedent” for future cases.  Case law will often determine what types of conduct are “negligent” and thus enable a party to prove negligence and win an award of damages.  Case law can be used to establish when a corporate officer has been negligent in his or her duties for a company.

States also have their own tax systems, which include employment taxes, corporate taxes, withholding taxes, annual fees, etc.

When determining if a particular state should be the state in which you incorporate, the issues you need to address relate to the kind of liability you want to avoid.  Based on the number of times this issue has come up, I believe there are a few common reasons that people believe they should shop for the “best” state to incorporate in.

First, people believe that incorporating in a state such as Nevada is better for liability.  The idea is that “liberal” states like California have “more liability” than states like Nevada.  This may be true; however, you can’t avail yourself of the “better” laws of Nevada simply by incorporating there.  In fact, if you operate a business in California, and register it as a Nevada corporation, it is unlikely that you will ever actually be involved in a case in Nevada.  Consider the average business: it operates in its home state, and rarely outside of that state.  If you’re the owner of a Nevada corporation with its principal office in San Diego, you will probably only ever end up in San Diego courts, which apply California law, not Nevada law.  In other words, most “external” liabilities are going to happen where you do business, not where you incorporate.  The place where you do business will apply its own law, and ignore the law of the state in which you incorporated (for the most part).

So, if you want to avoid general liability, you cannot get much benefit from seeking corporate registration in another state.  You also would be paying two states’ annual fees, because you still need to register your Nevada corporation in the state where you actually do business.  To do so, you pay the same fees that you would have paid to incorporate in that state; in essence you are doubling your annual fees, and not gaining the advantage you sought when you went out of state to incorporate.

The second reason people believe it is better to incorporate in Nevada or some other state is the idea that some states do not require that the shareholders be disclosed to the state.  So, the theory is that if you form a Nevada corporation, you can avoid having your potential creditors (or blood-sucking attorneys) find out that you own shares in a thriving Nevada corporation.  Here is the problem with this thinking.  If you want to keep people from knowing that you are involved with a Nevada corporation, then you need to not only avoid being identified as a shareholder, but you want to avoid being identified as an officer or director.  Nevada does not require registration on the shareholder side, but does require registration of officers and directors.

In order to be “invisible” in a Nevada corporation, you would need to hire an officer and director who will work for you and be listed on the annual list of officers and directors each year.  This is referred to as using a “nominal” director and a “nominal” officer.  This costs several thousand dollars per year.  It adds a significant complication to your business to do things this way.  It also might not protect you from any normal liability that could arise.  At best, it makes it more difficult for someone to find your assets, but it does not prevent the creditors and blood-suckers from suing you and eventually discovering this entity, and your ownership of the entity.

If you were sued, you could not “hide” ownership of the Nevada entity.  As such, what good does it do that you are not publicly listed as a shareholder?  In the end, all the complicated efforts to cloak your assets or activities are discoverable in litigation.  Again, all of the trouble just does not get you very far.

The third common reason that people believe Nevada is a better jurisdiction is that there are no corporate taxes, nor individual state taxes in Nevada.  Again, there are many misunderstandings about this issue.  In order to avail your corporation of the favorable tax laws of Nevada, you would need to obtain offices in Nevada and make it the primary, or only, office for your corporation.  However, when you draw your income from the corporation, either as a salary or as draws of your equity, you have to pay personal tax in the state where you live.  Thus, if you live in California, but operate a Nevada corporation (entirely in Nevada) you will still have to pay your California state taxes at the end of the year as a California resident.  The only true way to avoid state taxes is to move to Nevada, and operate your business out of a Nevada office.  Again, the costs of doing this are simply not worth the effort; the cost outweighs the gain.

The fourth most common reason that people believe that they should incorporate in a state like Nevada is that they will find more favorable shareholder law.  This is the first good reason on my list for incorporating in Nevada.  The laws that apply to the conduct of major shareholders as opposed to minority shareholders are slightly more favorable; bylaws may be amended with only a majority of shareholders voting, which enables corporate restructuring and major corporate decisions without the consent of minority shareholders.  The business laws are generally more favorable in terms of the rights of management.  There is no mandatory provision to allow for “cumulative voting” in Nevada, and there is in California.  In addition, Nevada allows a company to exchange stock for future services, where many states require that stock only be issued for “value” which can be “past” services, but not a promise of future services.  It is these reasons that drive many companies to incorporate in Nevada; similarly there are laws that are favorable under similar circumstances in Delaware, Minnesota, and a few other states that are trying to use favorable corporate law to lure more business activity, and more annual revenue from corporate filings.

If your company will have shareholders, then Nevada may be worth the effort.  Again, remember the three reasons that people believe make it a better jurisdiction.  Weigh the costs associated with duplicating your filings.  In the end, if you think that you will have shareholders, and can afford the cost and additional complications, then it could be worth the effort.  It does not have to be Nevada; it could be any number of other states.  If you plan to have shareholders, you will probably have an attorney through the process, and you can seek his or her counsel about which jurisdiction is right for you.  For most small businesses, it is most efficient to just incorporate in your home state and avoid the hassles of chasing the Nevada myth.