Authored by Mark Lobb
For over a decade, Lobb & Plewe, LLP has been counseling businesses and owners of businesses seeking to transition to Nevada and other low- or no-income tax states. With our home office in California, we have experienced a robust exodus.
In 2021, the Tax Foundation’s Tax and Climate Index ranked California at number 49 of all states for businesses. While New Jersey was able to out shame California, Nevada has a steady influx of migration from California, Illinois, New York, and other high income tax states.
California is notorious for relying on the climate to entice people and businesses to stay in the state. More recently, that strategy has not worked as hundreds of businesses and thousands of residents have left California since 2018. In 2021, California lost a U.S. House Congressional seat as the result of depopulation. While the history of politics in Sacramento disenfranchising the population is significant, you do not have to look too far to get a feel for the pain inflicted on the residents of the Golden State.
The U.S. is suffering from the worst inflation in 40 years. Wage increases are not keeping pace with inflation. In 2022, California was ranked the third most expensive state to live in with Hawaii in first and New York in second. California has the highest gas taxes in the U.S. On July 1, 2022, California raised the gas tax 5.6% to 53.9 cents per gallon. Ironically, at the time of the gas tax increase, the California state legislature announced it will create a committee to investigate why gas prices are so high. Apparently, the legislature sees no correlation between having the highest gas tax in the country and the highest gas prices.
On May 13, 2022, it was reported that the California surplus would balloon to $97.5 billion. This budget surplus is in addition to a fully funded rainy-day fund which the State is currently considering raising.
These examples of random tax increases and misguided messaging has led to the exodus by closely held businesses, business owners, and employees. Large companies are leaving as well or slowly migrating away from California. Recently Chevron announced it is selling the company headquarters in San Ramon, California, and downsizing. The “downsizing” consists of Chevron moving employees to Houston, Texas.
In 2018, I had three meetings with business owners in southern California. Without prompting, one informed me of an intention to move his business to Texas and the other two informed of their intention to move to Nevada. For years I had worked with clients moving into California and out of California, but the new trend was business only moving out of California. These three clients’ intentions to move out of the State in one day caused me to ramp up my services related to business migration. Since that day, our firm has assisted a steady stream of businesses moving out of California as well as assisting businesses moving into Nevada from all over the country.
Below are check list items for both businesses and business owners to consider when making a transition to another state.
- Regulatory: I have had numerous clients complain about the regulatory restraints in California. Before making the move, consider all issues pertaining to permitting and regulatory restrictions affecting your operations. Normally, if you are in a heavily regulated state, you will find greener grass, but the grass may have a softer landing in one state as opposed to another.
- Taxes: A state may advertise “low” or “no” taxes. Don’t assume anything. There may be no income taxes, but your company may die by a thousand cuts with fees and other disguised taxes.
- Entity Legal Migration: If you are expanding into another state to migrate growth or start a process of moving out of a state, you will need to have your existing entity become authorized to do business in the new state. If you are completely uprooting and moving, you may want to merge your entity into a new entity in the new state or create a wholly owned subsidiary in the new state to wind down business affairs in the exit state. There are many legal ways to approach the legal existence in the new state, all of which need to be considered.
- FTB and IRS Issues: Moving operations out of one state may protect business income from the exit state’s income taxes, but this is a very complicated issue and likely you will not immediately or ever completely sever the tax obligation of the exit state. If income is derived from sales or services in the exit state, or if the legal entity is a pass-through entity for tax purposes with a resident of the exit state as the owner, exit state taxes will be recognized.
If a full business transition out of the exit state is intended, it needs to be documented by terminating the tax status of the business in the exit state. A final tax return should be filed with the “final return” box checked on the return. This is a standard process for most all states.
Things are a little simpler with the IRS. Businesses should inform the IRS of the new business address, and if you have a pending audit, make sure the relevant IRS representative or attorney has the new information. If you are aware of the new address early enough in the year, you can inform the IRS by filing IRS Form 8822-B.
- Basic Legal Issues: Be prepared to understand and adapt to legal issues common to your business. The following checklist will be helpful:
- Employment Laws: You need to make sure you have any necessary postings for employees as required by state and federal law at your place of business. Are the rules regarding meal and rest periods rigid and if so, what policies do you need in place? Are there rules regarding exempt and non-exempt employees? What is the line between the classification of independent contractors as opposed to employees? Are non-compete agreements enforceable? Are there advantages to having employees sign mandatory arbitration agreements in case of an employee dispute?
- Contract Laws: It is imperative businesses understand the differences in the laws concerning contracts from the exit state to the new state and make sure any necessary adaptations are made to conform to the laws of the new state.
- Licensing: You may need to secure both state and local licenses to operate in addition to any other licensing requirements specific to your operation.
- Residency Issues: Likely a desire to avoid high state income taxes was a consideration in moving to a new state. You will need to make sure you comply with all residency rules relative to (1) no longer being deemed a resident in the exit state and (2) becoming recognized as a resident in your new state. Our firm has drafted detail memoranda for most low and no tax states concerning the residency requirements. We are happy to provide the information to you upon request. Each state has nuances to meeting certain “residency” requirements and if you are moving from a high tax state, you will want to meet every residency requirement possible.
- Estate Planning: To the extent you have an estate plan, it needs to be reconsidered in light of the tax, estate tax and estate planning laws in the new state as opposed to the exit state. It may be that you can avoid substantial income tax, eliminate estate tax more efficiently and have a more robust estate plan overall if you transition your trusts to the new state. Likewise, the asset protection laws in the new state may be more protective than the exit state.
- Tax Optimization: If you have intangible assets which are personal to you and have the ability to generate royalty income, you will want to make sure those intangibles are properly housed in the new state if the new state is a no or low tax state as compared to the exit state. If your operating company does not make a full transition out of the exit state which is otherwise a high tax state, you will want to apportion income relating to the intangibles to the extent the income is not sourced from the high tax state. Do not leave the intangibles hostage in the entity still operating in the high tax state.
- Asset Migration: Once you move, you may still have assets lingering in the exit state which are potentially subject to state court creditors. To the extent possible, you will want to maximize your access to the asset protection laws in the new state and migrate as many assets as possible from the exit state into the new state asset protection structures.
If you are going to make a transition to another state, make sure you are doing it correctly and maximizing all the benefits of the new state. Above is a sampling of the issues which deserve attention. Other issues will arise as you make the move and whether it is an item listed above or something you deem unexpected; our firm is skilled in assisting businesses and business owners during the business migration process.
Meet the Authors:
Mark Lobb is a founder of the firm and the Managing Partner of Lobb & Plewe. He focuses on matters concerning middle market companies which are closely held and the owners of such companies.
Kristin Gifford is a senior attorney in the firm. Kristin manages the Las Vegas office, and her focus is on legal matters concerning companies and their owners transitioning into Nevada. She also heads the private client group in Nevada and is the go-to for legal matters concerning closely held companies and their owners.