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Nevada Corporations |
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Asset Protection Flash presentation Private Nevada Corporation Benefits for Those in Another State or Country
This is the single most common situation our consultants encounter: an unincorporated business in a foreign jurisdiction (whether in another state or another country altogether). The questioner is considering incorporating, which is almost always a good choice, especially when compared with running a business as a proprietorship. They have heard some things about Nevada corporations and need more information to see how such an approach would work for them. They are concerned about the risk of a lawsuit and how it could take away everything they are working to achieve and they are probably also aware that there might be some tax benefits. For the purposes of this example we’ll keep things simple. Let’s call the business owner “John”. John would like to protect himself from liability, protect the assets he has worked hard to gain and, hopefully, pay a little less in taxes. But he wants to do it right and stay within all rules and guidelines, and he certainly doesn’t want to get in trouble with the IRS or any other government agency. Step by Step
Step by StepStep One (Whom Would I Benefit?) The first question John might want to ask himself is: “Whom would I like to inherit what I have built, if I was no longer in the picture?” He should put together a list of at least 6 people in answer to that question.1 Let’s say he’s married with two kids, has a brother and a sister and some friends on his list. Step Two (A Corporation in California) The next step John might take would be to establish a corporation for the California business. Instead of forming a California corporation, however, he could form it in Nevada and then qualify it to do business in California by registering it as a foreign corporation with California’s Secretary of State. California will simply want to know who will accept service of legal process on behalf of the corporation. Fine, John will act as the “resident agent” for the corporation in California. He gets a business license for the new entity, which for the purposes of this example we will identify as CALCORP, informing California’s Department of Taxation who owns the business. (It might be just John but it could be both him and his wife2.) Step Three (Acquire a Nevada Shell Corporation) Next, John borrows a couple of hundred dollars from each of his chosen “inheritors-to-be” and documents the indebtedness. (The point being that he does not buy the private Nevada corporation with his own money.)3 He buys a couple of money orders and then very privately acquires a Nevada shell corporation on their behalf. Let’s call this corporation NEVCORP. This corporation comes with contract officers and an individual other than John is identified on the public records as the incorporator and first director, and the contract officer’s name appears on the “list of officers and directors” filed with the State of Nevada. Everything that happens within this corporation happens behind a veil of privacy. NO STOCK IS ISSUED. Who owns this corporation?4 Who controls it? For whose benefit? No one on the outside knows because it’s simply not a matter of public record. Step Four (Set Up the Bank Accounts) John assumes the role of “agent” acting on behalf of the corporation. Or if he needs a little stronger position, such as the ability to sign contracts binding the corporation, he might approach the contracted Board and ask for a corporate resolution appointing him as, say, vice president. The bank opening an account for this corporation accepts a corporate resolution signed by the Board authorizing John to establish the account. Note that having signing authority over a corporation’s bank account does not mean that John owns or controls NEVCORP; he is just an agent or vice president authorized by the Board of Directors. In California, John works with his local bank officer and establishes a new account for CALCORP. Step Five (A “Terrible” Contract?)5 Everything is now in place and ready to implement an arm’s-length, two-corporation strategy. Here is just one of many ways this can work6: CALCORP (CC) contracts with NEVCORP (NC), whereby NC now acts as a “middleman” in purchasing inventory and supplies for the California-based business. The business suppliers invoice NC, which makes arrangements to have the items drop-shipped to the business in California. NC marks up the cost of goods and invoices CC for the higher amount. This deal can be very profitable for NC—at the expense of CC, “unfortunately”. (?) “Poor” John! (?)
A Wonderful OutcomeLet’s look at the results obtained by putting this strategy in place: Immediately, CC starts losing profitability. Whatever it earned as a proprietorship, it might be earning only half that amount now. It might even get to the point where CC can no longer afford to make payment in full for NC’s invoices. That’s alright because NC can afford to carry CC by extending it credit. As CC becomes indebted to NC, NC registers a UCC-1 lien against the assets of CC. The extent of the indebtedness and the rate at which it occurs is established by the contract between CC and NC. To modify these variables, the Board of Directors of NC could either relent or tighten the screws. John is certainly happy that NC’s Board is cooperative when it comes to issues like this. Liability IssuesLet’s say someone sues John’s business. As a sole proprietor, everything John owned and all he worked for many years to build would have been at risk. An asset search would have turned up his real estate, his bank accounts and everything of value in his name and it would all be on the line. The situation is not much different in terms of liability if John incorporates only CC because these days lawsuits typically name every person in sight. The lawsuit would undoubtedly list both CC and John as defendants. Not only CC but everything in John’s name would still be exposed to the potential liability. By implementing this simple strategy, however, there is considerably less at risk. It is not that there is any less liability; there is just a much smaller chance of the liability causing serious financial harm. And there is less risk of this lawsuit ever materializing in the first place: An asset search would certainly show a lot less “hanging out there”, so there is a reasonable chance that with little to gain the prospective litigant simply would not proceed. It’s a lot more lucrative to attack someone who has a lot of assets. Asset Protection IssuesAs a sole proprietor, all of John’s assets were at risk in addition to the assets of the business, which was in no way separate from himself, as an asset search would quickly reveal to any prospective litigant. The situation doesn’t change as a result of merely incorporating CC because it is him and he is it according to the alter-ego doctrine: There is a “unity of interest” between John and CC and a successful litigant will be able to hold John responsible for a judgment against CC. Proper application of this strategy doesn’t change the fact that John could lose everything in his own name. When it comes to the business, however, it’s a different story. CC’s assets were liened by NC before this lawsuit ever got underway. NC is a secured creditor, first in line to be paid upon liquidation of CC’s assets, at least until NC is fully repaid to the justifiable extent of its lien. CC is broke and John doesn’t have much personally, either, since he structured his life according to John D. Rockefeller’s sage advice to “Control everything; own nothing.” Taxation IssuesAs a sole proprietor, John was paying federal and state taxes on the entire net income of the business figured at his personal tax rate. By incorporating CC John gained some tax advantages, largely because corporations are entitled to a number of tax deductions not available to individuals. In addition, John could draw whatever income he needed to live on and keep some of the profit in the business as retained earnings—an effective income split resulting in a much lower personal tax rate, even though the business still must pay its state and federal taxes on its income. Not bad. With this strategy up and running, CC might never again have a profitable year, so its taxes could drop to zero. John would still be taxed on whatever income he takes personally but would probably need less to live on than he did as a sole proprietor because of certain expenses that can be taken corporately. NC would have to pay tax on its income—but there is no state tax in Nevada and the federal rate is just 15% on the first $50,000 of net income after allowable expenses. Nice. The Finished PictureJohn is living pretty much the same lifestyle now as he did before but he’s enjoying himself a bit more and has a lot less worries. It’s funny because he now finds that he can live on much less income than he used to need—and pays far, far less personal income tax. The California Franchise Tax Board isn’t hounding him for payments any more, either, since CALCORP showed nothing but losses for the last couple of years. Last month he went to Hawaii with his friends and family. The expenses were paid by NEVCORP because that is where it chose to hold its Annual Meeting. They’ll be voting on where the next meeting will be held, probably somewhere on the other side of the world because the business is getting more and more global. Australia sounds nice, “as long as the company’s paying the freight,” says John. He’s not as concerned about being targeted for a lawsuit as he used to be, either. Hey, when you’ve got nothing, you’ve got nothing to lose—right? He used to worry about how he could save up enough money in case his daughter wanted to attend a really good university. It’s comforting to know that money is very safely set aside for his childrens’ future. And it’s really nice to know that if a great business opportunity presents itself he can count on all the financial help he might need from one of Nevada’s better corporate citizens. He’s never been to Nevada but has certainly come to appreciate its pro-business attitude. Long-Term ConsiderationsJohn likes knowing that his California business has an option available to it of which few others (his competitors included) have taken advantage: His California company can simply cease doing business in California at any time and withdraw to the haven of Nevada with its business-friendly and protective statutes. Sweet. Best of all, perhaps, John has peace of mind in the knowledge that the corporate structure he has put in place can outlast him, no matter how long he might live. He knows the corporation will attend his family’s needs if he is no longer in the picture. The answer to the original question (“Whom would I like to inherit what I have built, if I was no longer in the picture?”) is explored further in the strategy relating to long-term planning. The base for a long-term plan is well in place already, however, and John can only marvel at how simple and easy it was to put it all in place.
Footnotes1 Why “at least 6 people”? Key IRS designations such as “Personal Holding Company” (which results in a surcharge of 39.6% on undistributed earnings) apply only to situations where there are five or fewer stockholders. 2 Eventually, John and his wife might end up with “his”, “hers” and “ours” corporations. For the sake of this example, we’ll keep things simple. 3 If John acquires the Nevada corporation shell with his own money, this estavlishes prima facie evidence that it is his corporation. It is far better to avoid the appearance that it is his when it truly is not. About the worst thing he could do is to pay for the acquisition of NEVCORP with his personal credit card. Don’t ask us why so many of our competitors are anxious to charge the sale on a credit card because it certainly can cause problems down the road. Money orders work just fine. We also can provide you with instructions for making a direct deposit to our corporate bank account at any branch of Bank of America. 4 Who owns a corporation in which no stock has been issued? The Board of Directors should make this determination and can do so by defining what constitutes “ownership interest” in the corporation’s bylaws. In Nevada, for instance, debt holders may be given all of the rights of stockholders; stock can be voting or non-voting; stock can be “uncertificated”; stock can be made payable to “bearer”; etc. An acceptable alternative (but which afford less flexibility in management) might be to issue just one “token” share to each of the “inheritors-to-be”. The Board controls the issuance of stock and there are normally 75,000 shares authorized, so while ownership is one issue, control is another issue altogether. The Board could, for instance, subsequently issue 74,994 shares to other parties or re-allocate percentage ownership to the original stockholders at the Board’s discretion. 5 People get involved with terrible contracts all the time. A court’s job is to uphold the contract as long as the contract is valid (lacking elements of fraud, duress, adhesion, etc.). Besides, this contract is not so terrible for John as it appears, since it helps him to accomplish numerous personal goals that might not otherwise be achievable. 6 In cases where the home-state business handles a physical product, middleman strategies can be very effective. When the nature of the business revolves around providing services, someone like John might act as an independent contractor facilitating sales on behalf of a private, arm’s-length Nevada corporation. In such cases, ensure that you understand and follow IRS guidelines regarding independent contractors. Talk to one of our consultants to arrive at the best strategy for your specific circumstances.
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“I live in California and run a small business here and I have been considering incorporation. How can a Nevada corporation benefit me when my business is here in California? Wouldn’t the Nevada corporation have to qualify and register to do business here and then wouldn’t it be treated just like any other California corporation?”
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