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Forming an LLC in Nevada

Is there really an advantage to basing your LLC in Nevada? Or is that just a myth? One business attorney spells out the pros and cons.

Excerpted From Forming an LLC (Entrepreneur Press)

Why has Nevada become America's hottest corporate haven? Advertisements touting Nevada's advantages appear everywhere, from airline magazines to e-mail spam. The answer is that throughout the past 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. [Because it's] business-friendly, offers low corporate income taxation, and offers managers and owners a great degree of liability protection for their business decisions and actions, Delaware has traditionally enjoyed an abundant stream of registration fees, and a sizeable industry developed to serve the corporations (and to a lesser extent LLCs) that filed there. Eventually, other states grew wise and mirrored Delaware's business-friendly approach. Nevada is easily the most notable example; the state began an aggressive program in the early 90s to attract companies to incorporate and organize there.

[But] Nevada is not a perfect business haven. It recently increased its incorporation and organization fees, making it one of the most expensive states in the nation in which to incorporate. Also, Nevada requires organizers to name an initial 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 managers) a great degree of anonymity.

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 doesn't tax corporate profits or LLC profits.
. Nevada doesn't 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 doesn't have an Information Sharing Agreement with the IRS. (There's no information to share, because there is no income tax department).
. 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 and LLCs 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's office provides excellent customer service and excellent web support.

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 doesn't impose a tax on corporate or LLC profits; many other states do, such as New York and California.

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, although it does collect a modest fee along with each LLC's List of Officers Report. 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.

Nevada's Privacy Protection Rules
Nevada offers a tremendous degree of privacy to owners of business chartered there. Note that this degree of privacy is not extended to directors and officers of Nevada entities. Nevada has no IRS Information Sharing Agreement-and Nevada isn't 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.

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 third parties to determine who a Nevada entity's owners are.

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.

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 aren't 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.

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 annual requirement that every corporation and LLC file an "Annual List of Officers and Directors." The oft-dreaded 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 website. 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.

Protection of Officers, Directors and Managers From Personal Liability
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:

1) His act or failure to act constituted a breach of his fiduciary duties as a director or officer; and
2) His breach of those duties involved intentional misconduct, 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. Using these funds, he 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. 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.

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're contemplating a corporation where you're the sole shareholder and the sole officer, this rule is irrelevant-you would obviously never sue yourself for making a mistake. But, if you're 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? LLC managers don't 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.

Purchasing, Owning, and Selling Shares of Corporation 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. 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.

Issue of Stock and the Valuation of Shares
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 one-third 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.

Disadvantages of Nevada Incorporation and LLC Formation
Nevada LLC formation does carry a few drawbacks that are for the most part largely outweighed by the benefits, among which are the following:

. 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.

Disclosure of Directors and Officers
As discussed above, Nevada requires the comprehensive disclosure of the identities of officers and directors. This disclosure is required in three places. First, initial corporate directors or LLC members must be disclosed in a corporation's articles of incorporation or an LLC's articles of organization. Second, both LLCs and corporations must disclose their management teams soon after organization in a form called the Initial List of Officers (corporations) or the Initial List of Managers or Members (LLCs). Third, both LLCs and corporations must annually disclose their management teams in a form called the Annual List of Officers (corporations) or the Annual List of Managers or Members (LLCs). The information from the initial list and annual list are then posted on the secretary of state's website.

Here's a warning: If you operate a member-managed LLC, you must disclose the owners of the LLC, because the owners are the managers. Because of this, member-managed LLCs must endure complete transparency in Nevada.

As noted above, Nevada's approach to privacy has two faces: Shareholders enjoy privacy, but officers do not. If you prefer not to have your management be so visible to the public, Delaware offers much greater privacy for management.

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, Nevada corporations are often used by unscrupulous business persons to accomplish illegitimate goals, such as hiding assets.

On the other hand, 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.

High Formation Expenses-and Balance
The initial incorporation expenses 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. So 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.

Learn more about the creating your own LLC in Forming an LLC (Entrepreneur Press).

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