Many startups incorporate in Delaware but are headquartered in other states. To further complicate matters, more startups are going fully remote since COVID-19. It can be confusing to understand whether a startup should qualify to do business and where.
This article helps founders understand the basic concepts involved in making this decision. As you’ll see below, the more you delve into this question, the more complex it becomes. Thus, it’s essential to work with your accountant to understand the right approach for your startup.
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Doing Business
Companies are not taxed based on where they are incorporated, but rather where they are “doing business.”
If a startup incorporated in Delaware (DE) meets the definition of doing business in another state, it must qualify to do business in that state. Each state has its own definition of doing business, but some common activities that may constitute doing business include:
- Maintaining a physical presence in the state, such as an office or warehouse
- Selling products or services in the state
- Having employees in the state
- Collecting sales tax in the state
In order to do business in another state, a startup must file a foreign qualification application with the Secretary of State of that state. The foreign qualification application will typically require information such as the startup’s name, address and registered agent in the state. The startup may also be required to pay a filing fee.
Failure to qualify to do business in a state where the startup is doing business can result in penalties, such as fines or even the loss of the right to do business in the state.
By doing business in a state, a company creates a nexus with that state for taxation purposes. All of these regulations were created in a brick-and-mortar world where doing business in a state was straightforward. However, with the advent of the internet, the regulations are harder to understand. Does the rise of e-commerce and remote work greatly expand every company’s footprint? Potentially.
Wayfair
The Wayfair case is a landmark Supreme Court case that overturned a 50-year precedent and allowed states to require out-of-state sellers to collect sales tax on sales to in-state consumers, even if the seller has no physical presence in the consumer’s state.
Wayfair opened the door for states to establish economic nexus standards for businesses, regardless of their physical presence. Currently, 18 states have a sales dollar threshold nexus standard, and 28 states and the District of Columbia have both dollar-based and transaction-based threshold standards. New Hampshire, Delaware, Montana and Oregon do not have a general sales tax. Alaska does not have a statewide sales tax, but does impose dollar-based and transaction-based thresholds at the municipal level.
Therefore, it is possible that just selling into a certain state, even via e-commerce, would require your startup to qualify to do business and pay taxes in that state.
Remote Workforce
Before COVID-19, many startups were already fully remote. Since COVID-19, it has become almost standard for early stage startups to have remote teams. However, having an employee in a state may create enough of a connection with that state to require the startup to qualify and pay taxes in that state.
The answer varies depending on the state. In general, a remote workforce can dramatically affect a company’s state tax nexus footprint. This is because companies are generally considered to be doing business and subject to a state’s tax laws if they have employees working in that state. For instance, according to Massachusetts, internet cookies and apps are enough to establish a physical presence. Having even a single out-of-state remote employee can create a tax nexus in certain states. If you have payroll in another state, you should discuss with your accountant. You may very well need to qualify and pay taxes in that state.
Ultimately, states are looking to increase revenues without raising taxes on their citizens. Therefore, making foreign companies pay more taxes is politically compelling.
Yes, Startups Need to Qualify in Their Home State
There seems to be no ambiguity that a company is doing business in the state where they are headquartered. So, you should qualify in that state for sure. As you can see above, it’s possible / likely that you may need to qualify in other states as well.
In conclusion, determining whether or not your startup needs to qualify to do business in a state can be a complex and confusing task. It’s important to work with your accountant to understand the right approach for your startup, and to comply with the regulations of each state where you are doing business. Failure to qualify to do business in a state can result in penalties, such as fines or even the loss of the right to do business in the state. The Wayfair case and the rise of remote workforces have made it even more important for startups to understand the regulations surrounding state tax nexus. Working with your accountant to comply with these regulations can help ensure the long-term success of your startup.
