The question of whether a corporation is “doing business” in a particular state is very difficult to answer because it depends on all the facts of a specific situation, the laws and court decisions of the state in question, and purpose for which the question is being asked. There are three different reasons for asking the question. First, to determine whether the courts of a state have jurisdiction over the corporation if a lawsuit is filed (or, conversely, whether the corporation can bring a lawsuit in the state). Second, to determine if the company is required to qualify as a “foreign corporation” in the state in addition to its incorporation in its home state. And third, to determine whether the corporation is required to pay taxes in a state. Most of the court cases relate to the first issue. Those cases might or might not be dispositive in a case arising under the second or third issues. This uncertainty is unfortunate because the consequences of being found to be “doing business” in a state can be quite serious if a corporation has not qualified as “foreign corporation” or has not paid the required taxes.
Several states impose monetary penalties on corporations that “do business” in the state without qualifying as a foreign corporation in the state. Some of these states not only allow for penalties to be imposed on the corporation but also on individuals acting on behalf of the corporation. These states that provide for personal liability are California, Delaware, Louisiana, Maryland, North Dakota, Ohio, Oklahoma, Utah, Virginia and Washington.
With regard to taxes, states are becoming more aggressive about finding sources of revenue. One potential source is income tax on the portion of business done in the state by foreign corporations if the contacts with the state are significant enough to subject the corporation to the state’s tax laws. It is not sufficient to say that if the corporation is not qualified in the state, the state will never know about the corporation’s income that isn’t taxing. State tax authorities are much more sophisticated in collecting information than is commonly assumed. Moreover, seven states now have laws allowing individuals to act as “tax whistleblowers” and collect a reward. These states are California, Delaware, Florida, Nevada, Illinois, Indiana, and Rhode Island, although the last three do not apply the law to incomes taxes but only other forms of tax, such as sales taxes. This is a growing trend and other states are likely to pass similar tax whistleblower laws. The problem with failure to pay taxes is not just the tax itself but also the penalties and interest. Interest on unpaid taxes is 1% per month in many states. If a foreign corporation is found to have failed to pay state income taxes for several years on a portion of the income earned in a state, the total tax bill can be huge.
To answer the question of whether a corporation must qualify in a state as a foreign corporation, the first step is to examine the state’s corporation law. The problem here is that some of these state laws provide a list of activities that, taken in isolation, do not require qualification in the state. What if more than one item on the list applies? Two items? Five items? How many are too many? Similarly, the Model Business Corporation Act provides that “…a foreign corporation shall not be considered to be transacting business in this State, for the purposes of [qualification], by reason of…[c]onducting an isolated transaction completed within a period of thirty days and not in the course of a number of repeated transactions of like nature.” Over two-thirds of the states have adopted this Model Business Corporation Act or the Revised Model Business Corporation Act, which is substantially the same in this provision. Again, how many transactions constitutes a “number of repeated transactions”? The available court cases are not very helpful because they generally dealt with situations where the transactions were either rather clearly isolated or, on the other hand, part of a regular course of business. The real question is where those two opposites meet.
Is there any guidance to be drawn from this complex web? Yes, three points. First, it may not be enough to merely select a state of incorporation, file articles of incorporation, and ignore the other states where business might be conducted. (Many new corporations are formed in Delaware and no thought is given to the state in which the corporation is actually located.) Second, ignorance is not bliss. And third, if there is any doubt about whether qualification as a foreign corporation is necessary in a particular state, it is a good idea to get written advice from a lawyer or tax adviser. If the advice is that qualification is not necessary, this will show the state authorities, if they should inquire, that the corporation acted in good faith. The defense of “Gee, I didn’t know” does not carry much weight.