Nevada is not a perfect corporate haven. Those seeking to incorporate in Nevada (about $280 for a bare-bones incorporation) far exceed Colorado’s $50 incorporation filing fee or Florida’s $70 filing fee. Nevada has recently nudged its fees upwards, and based upon that, one can reasonably expect that it will continue to do so. Also, Nevada requires organizers to name an initial director in the articles of incorporation, or (in the case of an LLC) name an owner or manager in the articles of organization. This appointment then becomes part of the entity’s public record, ultimately searchable by anyone over the internet or through the Secretary of State’s office. Despite this, Nevada is otherwise generally a ‘privacy state,’ one that offers its owners (but not its directors) a great degree of anonymity. We’ll discuss Nevada’s privacy rules at length below. But why has Nevada become America’s hottest corporate haven?
Advertisements touting Nevada incorporation advantages appear everywhere, from airline magazines to email spam. The answer is that throughout the last few decades the Nevada Legislature underwent a conscious, deliberate, and effective program to make its state business-friendly and corporate-friendly.
Traditionally, the most popular state for incorporation was Delaware, and its dominance began early in our nation’s history. Delaware is corporation-friendly, offers low corporate taxation, and offers officers and directors a great degree of liability protection for their business decisions and actions. For this reason, the state of Delaware has traditionally enjoyed an abundant stream of registration fees, and a sizeable industry developed to serve the corporations that filed there.
Eventually, other states grew wise and mirrored Delaware’s corporation-friendly approach. Nevada is easily the most notable example; Nevada began in the early 90s with an aggressive program to attract companies to incorporate in Nevada . The remarkable growth of Nevada’s filings in the past 10 years reveal that Nevada’s business-friendly and corporate-friendly environment is working. Why Incorporate in Nevada? The Advantages of Nevada Incorporation or LLC Formation Nevada incorporation carries many benefits, among which are the following, and all of which are described in detail below:
Nevada does not tax corporate profits or LLC profits.
Nevada does not tax corporate shares or LLC ownership. Some states (not many, mind you) tax individual shares in a company.
Nevada has no franchise tax.
Nevada has no personal income tax.
Nevada does not have an Information Sharing Agreement with the US Internal Revenue Service.
Shareholders in a Nevada corporation and owners in a Nevada LLC are not a matter of public record — shareholders can remain completely anonymous.
Officers and directors of a Nevada corporation can be protected from personal liability for lawful acts of the corporation.
Nevada corporations may purchase, hold, sell or transfer shares of its own stock.
Nevada corporations may issue stock for capital, services, personal property, or real estate, including leases and options.
The directors may determine the value of any of these transactions, and their decision is final.
The Nevada Secretary of State provides excellent customer service and excellent Web support.
Incorporate in Nevada: Nevada’s Generous Taxation Rules for Businesses
Nevada enjoys a windfall of tax revenues from its most notable industry: gaming. As a result, Nevada’s residents and business enjoy some of the lowest state taxes anywhere. Nevada does not impose a tax on corporate profits; many other states do, such as New York and California. California even imposes a 1.5% income tax on S Corporations, which do not pay income tax at the federal level. Similarly, Nevada imposes no tax on corporate stock or LLC ownership shares. This isn’t saying much; almost no states impose taxes based on stock or ownership. Nevertheless, by way of comparison, New York imposes an annual filing fee on LLCs of between $325 and $10,000, depending on the number of LLC members.
Nevada imposes no franchise tax. A franchise tax is a tax levied in consideration for the privilege of either incorporating or qualifying to do business in a state. A franchise tax may be based upon income, assets, outstanding shares, or a combination. Put another way, a franchise tax is a tax one pays for ‘just being there.” Many states impose franchise taxes on businesses. While Nevada’s Secretary of State touts the absence of a personal income tax as a benefit to businesses, this is more of a reason to reside in Nevada, and not really a reason to incorporate in Nevada . Personal income tax is paid in an individual’s state of residency and not in the state where his entities are chartered. For example, a California resident that operates a Nevada corporation will be subject to California’s personal income tax on corporation income paid to her despite her choice of Nevada for the state of charter for her corporation. Nevada’s Privacy Protection Rules Nevada offers a tremendous degree of privacy to those seeking to incorporate in Nevada . Note that this degree of privacy is not extended to directors and officers of Nevada entities. Nevada has no US Internal Revenue Service Information Sharing Agreement–and Nevada is not afraid to boast about it. The IRS has in place an Information Sharing Agreement (‘ISA’) with about 33 states. The purpose of the ISA is to combat abusive tax avoidance. Even if Nevada participated in the agreement, it would have no information to share. Because Nevada has no corporate income tax and no personal income tax, it has no corresponding tax forms and no corresponding tax department. Under agreements with individual states, the IRS will share information (and vice versa) on abusive tax avoidance transactions and those taxpayers who participate in them. As reported by the IRS, states that participate in the ISA include Alabama, Arizona, Arkansas, Connecticut, Georgia, Florida, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Minnesota, Mississippi, Missouri, Montana, New Hampshire, New Mexico, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, South Dakota, Utah, Vermont, Washington, West Virginia and Wisconsin. Along the same lines, owners of Nevada LLCs and shareholders of Nevada corporations need not identify themselves in any public records. This makes it very difficult for the government, police, or for third parties to determine who a Nevada entity’s owners are.
Unfortunately, Nevada’s privacy protections are widely misused. By way of example, and not by way of recommendation, many individuals and businesses have improperly and illegally used Nevada business entities to hide assets from creditors and even their own spouses. The other obvious misuse is tax avoidance. Despite occasional abuse, Nevada’s privacy protections do offer value to the legitimate and law-abiding businessperson. Probably the single greatest benefit of Nevada’s privacy protections is that it serves to protect business owners from unscrupulous creditors, aggressive attorneys, and frivolous litigation. In my law practice, I have served as counsel to several companies that have been the victims of lawsuits that could only be fairly described as totally baseless. Often, the owners of businesses are dragged into the suit as defendants simply as an intimidation tool. Frivolous lawsuits are an unfortunate reality in today’s business climate. Also, lawsuits are never win-win, they are always win-lose; the successful defense of a lawsuit following the time and expense of a trial is not a pure victory, it is a victory that comes at great cost. The real victory is not to ever be sued. Experienced businesspersons and lawyers know this. Nevada’s privacy protections can go a long way in achieving this goal by effectively hiding business owners from public view and thereby protecting them from litigation. Of course, Nevada’s privacy protections are not absolute, they do have limits. A good plaintiff’s lawyer with enough money and time (it would take a lot of both) could ultimately peek into a Nevada entity’s ownership. Overall, though, Nevada’s privacy protections are quite valuable. The other obvious benefit to the businessperson of Nevada’s privacy protections is shelter from the prying eyes of government. This benefit is obvious, even to a completely law-abiding company or company owner. Our government, police, and courts, while the finest anywhere, are capable of occasionally pursuing the innocent. Again, the successful defense of a criminal matter following the time and expense of a trial is not a pure victory, it is a victory that comes at great cost. Privacy, for lack of a better term, is good. I am quite comfortable advising my business clients to maintain their privacy as much as possible in their business affairs regardless of the type of business they conduct. As a general rule, that which need not be disclosed should not be disclosed. Nevada’s privacy rules have an important exception, however. Nevada’s privacy protection carefully protects owners and shareholders, but such privacy protection does not extend to company officers, directors, and in the case of LLCs, members. Nevada is one of a few states that requires an incorporator or organizer to appoint by name at least one initial director in a corporation’s articles or in the case of an LLC, at least one member in the articles of organization. In both cases, the articles are a public record, and anyone can request copies by paying a small fee. Even worse, however, is Nevada’s requirement that every corporation and LLC file an “Annual List of Officers and Directors” each year–the oft-dreaded Annual List requires companies to disclose the full names of their officers and directors, and the information is then posted on the Nevada Secretary of State’s Web site and is searchable through any web browser by anyone. This easily searchable public database makes it remarkably easy for any member of the public to determine a Nevada entity’s management team. Keep in mind, however, that Nevada does offer a great degree of privacy to owners–as long as those owners do not participate as managers; such owners can easily remain anonymous. By comparison, Delaware (as well as many other states) require no disclosure of the identities of officers and directors.
Insider Tip: Nevada’s schizophrenic approach to privacy (complete anonymity for shareholders, but complete disclosure of managers, directors, and officers has produced an interesting cottage industry: the nominee director. A nominee director is an appointed manager/officer that serves as the appointed public representative of a corporation or LLC. The nominee director/manager is often charged with a solemn duty: to serve as the guardian of an entity’s owners’ privacy– the entity’s owners “hide” behind the publicly disclosed nominee director. A common use of a nominee director is for asset protection; a Nevada entity owner that wishes to hide assets can assign the assets to the Nevada entity and can then appoint a nominee director and the owner can thereby direct the nominee director to serve the owner’s interest. The use of nominee directors, however, has little value to an ordinary small business, but is an effective device for asset protection.
Protection of Officers, Directors, and Managers From Personal Liability for Lawful Acts of the Corporation or LLC Directors and officers of Nevada corporations enjoy generous protection (sometimes called “indemnity”) from personal liability to the corporation or to a corporation’s shareholders in connection with their service to the corporation. Nevada’s rule on director and officer liability states: A director or officer is not individually liable to the corporation or its stockholders or creditors for any damages as a result of any act or failure to act in his capacity as a director or officer unless it is proven that: (a) His act or failure to act constituted a breach of his fiduciary duties as a director or officer; and (b) His breach of those duties involved intentional misconduct, fraud or a knowing violation of law. The preceding passage is a pro-management version of the “business judgment rule.” The business judgment rule that is in effect in most states dictates that courts will not review directors’ business decisions or hold directors liable for errors or mistakes in judgment, so long as the directors were
1. disinterested and independent; 2. acting in good faith; and 3. reasonably diligent in informing themselves of the facts.
Obviously, Nevada goes much farther, allowing liability to attach to directors and officers only when the director or officer breaches her fiduciary duty or commits fraud or a knowing violation of law. So, how would this rule apply in the real world? Well, imagine a Nevada corporation with five shareholders and one director/officer. Assume the officer caused the corporation’s funds to be withdrawn from the corporation’s savings account with the funds he thereafter caused the corporation to purchase a risky stock investment on a tip from a friend without making even a simple inquiry into the worthiness of the investment. Assume further that the stock investment went sour and caused the corporation to lose $50,000. This is a common model discussed in law school classes. The likely outcome depends on whose law applies. In Nevada, the protective officer liability rule would shield the officer from liability. Sure, he made a bad investment of the corporation’s funds, but he broke no law and committed no fraud. The corporation and its shareholders would therefore suffer the loss without recourse against the officer. In a state that follows the general business judgment rule (keep in mind that every state will have a slightly different rule) the officer might face liability from the corporation or the shareholders. Because the officer was not diligent in informing himself, his decision would likely be found to be liable for his error. Of course, when directors and officers enjoy enhanced rights, some other party will suffer diminished rights. Such is the case here. The protective business judgment rule in Nevada restricts the rights of the corporation and shareholders to pursue claims against the officer. Now, if you are contemplating a corporation where you are the sole shareholder and the sole officer, this rule is irrelevant–you would obviously never sue yourself for making a mistake. But, if you are an officer, director, or both you may want the protection against lawsuits and claims made by shareholders.
But what about liability protection for LLC managers? The preceding passages discussed the liability protection of corporate directors in Nevada. LLC managers do not enjoy the same protection that corporate directors and officers enjoy. Essentially, LLCs have the option of protecting managers to the same extent as corporate officers, but this decision can be overridden by a vote of the majority of the owners of the LLC. If iron-clad indemnity protection is important to you, the corporate form will offer greater protection.
Nevada Corporations May Purchase, Own, and Sell Shares of Its Own Stock
A Nevada corporation may purchase, own, hold, sell, transfer, pledge, or assign shares of its own stock. This may not seem important, but actually this is an important and convenient right that I find quite useful. Not all states allow corporations to own their own shares. Shares of a corporation held by the corporation itself are known as “treasury shares.” The process of transferring shares into the name of the corporation is familiarly known as “returning shares to treasury.” Keep in mind that the corporation cannot issue new shares to itself, treasury shares are only acquired through transfer back to the corporation from a third party that formerly owned the shares. In practice, treasury shares might work as follows: Assume a corporation issues shares to a shareholder in exchange for services. If the shareholder fails to perform the services, or performs the services poorly, the corporation might have a claim against the shareholder. A convenient method of resolving that dispute is to have the shareholder transfer the shares into the corporation’s treasury in exchange for a release of the corporation’s claim. This is a very common way by which a corporation acquires treasury shares. Once the corporation receives the shares, it can hold the shares or sell the shares to another party. Keep in mind, however, that treasury shares do not carry voting rights, and are not entitled to dividends and distributions.
Nevada Corporations (and LLCs) May Issue Stock for Nearly Anything of Value, and the Valuation of Shares Cannot Be Questioned
Nevada corporations (and LLCs) may issue stock for nearly any sort of consideration: capital investment, services, personal property, or real estate, including leases and options. Not all states grant such power to a corporation. This is an important and convenient right that Nevada corporations enjoy. This freedom allows Nevada corporations to issue shares for the services of employees and consultants. Perhaps more importantly, the corporation’s directors may determine the value of any of these transactions, and their decision is final. This rule is advantageous to organizers of companies–it gives them the power to adjust stock ownership as they see fit. For example, if three persons come together and want to form a corporation, but only two of the three owners have capital to invest, the third owner can join the corporation or LLC as a 1/3 owner and her contribution to the entity can be an employment contract. The directors enjoy the power to value the employment contract as they wish, and that decision can never be questioned.
The Nevada Secretary of State Provides Excellent Customer Service and Excellent Web Support.
Nevada has wisely organized the Secretary of State’s office into an efficient and effective customer service organization. The office is not perfect, but generally speaking, it is an effective organization. First, the Secretary of State’s Web site is informative and easy to navigate. The searchable database allows one to quickly check on the status of one’s own corporation or LLC. Is one’s entity overdue in its annual report? Is one’s entity in good standing with the Secretary of State’s office? What are my filing fees for my annual report? A simple check on the web will answer these questions. The Secretary of State’s Web site also offers a plethora of easy-to-use forms in portable document format (PDF) that can be easily viewed and filled out with a standard web browser. We’ll cover the preparation of forms below in Chapter 6: The 14 Steps to Nevada Incorporation. Note that in the last few years, Nevada has moved to a system where Nevada corporate and LLC filings are only accepted if filed on Nevada’s pre-printed forms. Formerly, Nevada allowed both pre-printed forms and traditional typed documents. Nevada also allows persons to make filings by facsimile–not every state allows facsimile filings. I find this to be an invaluable convenience, and it can usually save one day and $20 of overnight charges. Nevada processes filings quickly. A typical filing will be processed in three to seven days, but there is a variance depending on their workload. For a fee of $125, users can request 24-hour processing. So, a filing that is faxed on a Monday with the expedite fee will be processed on Tuesday and can be delivered by overnight delivery on Wednesday. Disadvantages of Nevada Incorporation and LLC Formation Nevada incorporation and LLC formation does carry a few drawbacks that are for the most part largely outweighed by the benefits, among which are the following, and all of which are described in detail below:
In Nevada, you must select and name your initial directors in your articles of incorporation. Nevada requires an annual filing in which you must disclose the identities of your management. Nevada recently increased its incorporation fees, making it one of the most expensive states in the nation in which to incorporate. Nevada corporations carry a slight stigma because Nevada corporations are often used by unscrupulous business persons to accomplish illegitimate goals, such as hiding assets. Many corporation service companies openly tout Nevada as the best state to incorporate in order to achieve certain illicit goals.
The Nevada Stigma
Unfortunately, Nevada corporations carry a faint stigma. Many corporation service companies openly tout Nevada as the best state to incorporate in order to achieve certain illicit goals. Furthermore, Nevada’s reputation for vice in other areas may add to its “corporate stigma.” True, unscrupulous business persons sometimes incorporate in Nevada to accomplish illegitimate goals, such as hiding assets. On the other hand, the stigma is slight, and I have found that it has never hampered the goals of my clients and their business. Furthermore, in the day to day operation of your business, most persons you deal with will not necessarily know your state of incorporation. Your business correspondence will carry the name of your corporation, but you need not disclose your state of organization.
Nevada Has High Formation Expenses–But Balance It
Nevada recently increased the fees to incorporate in Nevada , making it one of the more expensive states in the nation in which to incorporate. The initial fees to incorporate in Nevada (about $280 for a bare-bones incorporation) far exceed Colorado’s $50 incorporation filing fee or Florida’s $70 filing fee. Of course, Nevada charges far less than California’s $900-plus organizational filing fee. Nevada has recently nudged its fees upwards, and based upon that, one can reasonably expect that it will continue to do so. Not only are the initial filing fees expensive, but the annual report filing fees are expensive ($125 minimum), as well as the fees for filing amendments to articles ($175 minimum), and articles of merger ($350). On the other hand, Nevada’s taxation is favorable. There are two lessons here. First, Nevada has likely had to raise its fees to keep the slim tax revenues up. Second, as a businessperson, you’ll simply need to balance the incorporation and periodic expenses against the more forgiving tax environment.