Corporations Don't Always Come Out Ahead in Nevada.

FOR several years now, the Nevada secretary of state and many incorporation services have been touting that state as the new corporate haven, offering advantages that many states can't match.

ENDRIES

Unfortunately, they are only telling half the story.

Nevada is a pro-business state, aggressively offering benefits to firms incorporating there. Its unique corporate structure is based on Delaware corporate law, and offers the additional advantage of protecting the privacy of investors and owners of Nevada companies.

Tax advantages are probably the biggest attraction to companies wishing to incorporate in Nevada, which is one of only four states with no corporate income tax. Still, those firms may end up paying taxes in other states in which they do business.

If a Nevada company operates in any other state that does have a corporate income tax, the firm must also qualify to do business and pay corporate income taxes in that state.

Nevada also has no personal income tax, business and occupation tax, stock transfer, or gift tax. However, many states also lack these taxes. And California, like Nevada, does not have a stock transfer or gift tax.

Incorporation services claim another advantage offered by Nevada is privacy, due to its minimal reporting and disclosure requirements. Nevada corporations are not obligated to publicly disclose the dates and times of annual shareholder and director meetings, the number of shares issued and outstanding, a corporation's places of business outside of the state of incorporation, or the identity of its shareholders.

However, once a Nevada corporation transacts business outside that state, this privacy is lost. Each state requires a company not incorporated there that engages in business activities within that state to qualify as a foreign corporation. As part of that process, many states demand information that Nevada might not require.

Thus, a Nevada company, qualified to do business in another state, may lose privacy protection offered in Nevada by the disclosure of such additional information.

Not talking to IRS 

Nevada's strongest privacy advantage is that it does not exchange information with the Internal Revenue Service. Because Nevada has no state tax and does not maintain much information on its own residents or its companies, the state has refused IRS requests for reciprocity of information.

However, every other state freely exchanges information with the IRS. Therefore, once a Nevada company has qualified as a foreign corporation to do business in another state, the IRS, through the other state's reporting requirements, will be entitled to all information disclosed.

One important advantage that Nevada does offer -- and probably the only reason for a company to incorporate there if it plans to engage in activities outside the state -- is limited liability. The Nevada Revised Statutes basically say that all corporate representatives are free from personal liability from corporate activities except in cases of fraud.

Nevada firms may include in their articles of incorporation a provision limiting or even eliminating the personal liability of a director, officer or stockholder for damages for breach of fiduciary duty. But such a provision must not limit liability for acts or omissions that involve intentional misconduct, fraud or a knowing violation of law, or for the payment of fraudulent distributions.

However, a director is fully protected when relying in good faith on company books or statements prepared by any of its officials concerning the value and amount of the assets, liabilities or net profits.

Meanwhile, the California Corporation Code only allows a company to limit the personal liability of a director in the breach of duties to the corporation and its shareholders.

And no such provision can limit the liability of directors for intentional misconduct or a knowing violation of law; acts or omissions that a director believes to be contrary to the best interests of the corporation or its shareholders; and acts or omissions that show a reckless disregard for the director's duty.

`Corporate veil'

Nevada also has made it very difficult to "pierce the corporate" veil" and thereby protect shareholders from acts of the company. For example, Nevada courts have generally held that under-capitalization of a firm by itself is usually insufficient reason to pierce the corporate veil, absent fraud or injustice.

Under California law, if an out-of-state corporation has more than 50 percent of the average of its property, payroll and sales in this state, and if more than 50 percent of its voting stock is held by people with addresses in California, the corporation must comply with California corporate law as if it were incorporated here.

This prevents a corporation doing the majority of its business in California from escaping the requirements of state corporate law. Thus, incorporating this type of business in Nevada will not allow the protection of Nevada law.

Unless a company actually engages in activities solely in Nevada, it probably is not worth the time and effort to incorporate there. That's because most benefits Nevada offers to entice prospective companies are lost when they engage in business activities outside Nevada.

While the liability protection Nevada offers to its directors, officers and shareholders is attractive, unless a company plans to engage in risky business activities, the effort to maintain a Nevada company and qualify as a foreign corporation elsewhere probably outweighs this benefit.

Leland J. Reicher is a partner and Kari H. Endries is an associate with the law firm of Reish & Luftman in West Los Angeles.

Entrepreneur's Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California.