Let?s assume that you have a Delaware corporation, your business is on the Internet and sells to customers all over the world, your servers are hosted in Virginia, your bank account is in Nevada, you have an Independent Contractor selling your services in Washington and you operate out of your home in California: Do you need to file an Authority to Do Business in any one or more of these states?

It is easy to understand why small business owners are confused about where and when they must "register" their companies with a state (outside of their state of formation) and in what form. State agencies make this issue extremely confusing as there is usually no black & white standard describing when and where a small biz owner must obtain a foreign authority to operate a business in that state.

I will attempt to explain what most state laws say on this issue and how to avoid some of the pitfalls of establishing what is called, ?nexus? in a state you might not want to. Additionally, I will attempt to help you determine when and where you must register your company if you are operating, in any form, in a state other than your formation state.

Many states have said that the requirement to obtain authority to do business exists to protect domestic organizations (those corporations & LLCs formed in that state) from unfair competition and to place domestic and foreign organizations (those formed in another state or country) on an equal footing. In fact, it is a way that states can ensure that they receive taxes from companies doing business there.

Domestic companies, they say, are required to collect taxes and pay taxes to that state. The argument is that foreign companies, who have lower costs because they are not forced to collect taxes, have an unfair competitive advantage. Additionally, if these foreign companies don?t collect taxes on sales, then wise consumers will be more inclined to purchase from the foreign company at an overall lower price.

The law is clear; a state cannot impose a tax on an out-of-state business unless that business has a ?substantial nexus? within the taxing state. But what exactly is substantial ?nexus??

The Supreme Court, on at least two occasions, has construed this ?substantial nexus? requirement when it comes to collecting taxes, requiring that the out-of-state (foreign) business must have ?more than de minimus? physical presence in the taxing state. The key here being ?physical presence.? Many recent state level cases have used the physical presence standard when imposing taxes on foreign companies.

Previous Supreme Court precedents held that taxpayers acquired a substantial nexus with another state through continuous and systematic contacts with the state. Recently, states have been seeking to expand their right to tax foreign companies which have only an economic presence in the state. At this time though, the physical presence standard is holding and the one most companies should follow.

So, ?what exactly is physical presence?? you might ask. This is a large point of contention as it is hard to find clear nationwide standards. Many states have created their own standards for establishing physical presence and therefore nexus allowing it to, in clear conscience, tax a foreign company. These standards, when defined, vary greatly in each state. For instance, if you are a trucker who drives through Massachusetts, substantial nexus occurs if you make more than twelve pickups, deliveries or trips through Massachusetts. This standard does not exist in any other state.

Unfortunately most state are more confusing as they do not clearly define when a foreign company has established physical presence within that state.

So, when it is not clearly defined, how does a company determine if it has physical presence in a particular state? Again, there is no standard that applies absolutely to all states especially those states don?t have clear objective standards. However, based on the norms of most states, you can be pretty sure that you have established physical presence and therefore substantial nexus if you:
1. Lease or own a building that you use as office, retail, or industrial space for your business and/or
2. Have W2 or 1099 employees in that state and/or
3. Collect state sales or payroll taxes on behalf of that state for products/services sold

If any of these three items apply to your company, then you probably have enough of a physical presence in the state to have established nexus.

If you are a corporation or LLC and you have nexus in a state, which is foreign to your state of formation, then you must register your INC or LLC with that state. This is what is meant when we say, ?obtaining authority to do business in another state? or Foreign Authority.

Foreign Authority is the authority given by a state to do business in that state as a foreign business. Again, the state wants you to be registered so that it can track your company for tax purposes, just like a domestic company. Even if you aren?t going to be paying taxes to the state, you will still need to receive Foreign Authority from that state. Usually, this involves the filing of a Foreign Authority registration with the same state agency in which you would form a new domestic entity.

If you ask most state agencies this question, they will usually say, ?now.? Remember, most state agencies do not have objective criteria for physical presence: Most state agency employees won?t even know what physical presence, much less substantial nexus means. Practically speaking, when to obtain an authority is truly a timing issue. In general, you should file a Foreign Authority before you start conducting business in that state. For instance, you may have leased an office space in a state months before you begin to operate in that state. However, other practical issues may force you to obtain authority before you begin operations. Some states? (i.e. CA, FL & NY) banks will require that you are registered in that state BEFORE they will even open up a business checking account. Some states, where you are going to need licensing, may require your company obtain authority before obtaining a license.

So why not just register now, so that it doesn?t become a problem later on? This may be the case in many states in which you are going to be operating. However, some states, like California, charge minimum taxes due only a few days after registration (LLCs must pay $800 on the 15th day of the third month after registration in addition to taxes on the LLC?s income).

Be sure you check with your own state for it?s specific rules on foreign authority filing.

What if your business is operating in another state, but it doesn?t have a ?physical presence? as per the norms described above? Because your business should have a physical presence somewhere, you could argue that your physical presence is in your state of formation. But how do you do that if you are formed in a state in which you have no physical presence (i.e. in most Delaware & Nevada incorporations)?

More specifically, let?s say you are formed in Delaware or Nevada and you live in California, but you don?t have a physical presence there, and you want to avoid California?s state taxes.

One method often employed is the set up of a physical office address & bank account in your state of formation or in another state with little or no tax liability potential. The address and bank account add to the argument of physical presence in a state other than California.

Building this type of argument is especially important if any of states you are operating in contend a presence, and therefore a right to assess taxes.

Probably most important regarding this issue is to make sure that you are aware of the laws in those states in which you might have a physical presence. Beware of possible changes, because the laws will change in many states. States, under pressure of mounting deficits, are looking for ways to supplement existing tax revenue by taxing more companies. The most common target is the company who sells its services or products to state residents over the Internet.