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Forming your LLC in Nevada: does it really work?

If you've done a lot of web research about setting up a limited liability company, or LLC, you've seen the advertisements that tout Nevada. The pitch is pretty simple. Because Nevada doesn't levy an income tax on individuals or corporations, you should form your LLC in Nevada. The implied promise is that you'll save big on state income taxes.

Don't get me wrong--I like saving income taxes as much as the next tax accountant. But the Nevada LLC formation question is trickier than most new entrepreneurs seem to understand.

Unless all of your business activity is in Nevada--and it probably isn't unless you're a Nevada resident operating a business in Nevada--you'll need to apportion your business income among the states where you operate.

This apportionment amounts to a three-step process; to make the steps concrete, let's assume that your business makes $300,000 a year.

Step #1: Apportion One-Third Based On Payroll

One-third of your income gets apportioned to the states where you operate based on payroll. In other words, if your business makes $300,000 a year, $100,000 of the profit is assigned to states based on the payroll expenses that your business incurs.

If your payroll were split evenly between California and Arizona, this would mean that $50,000 of your profit would be apportioned to California and another $50,000 would be apportioned to Arizona entirely on the basis of payroll. Notice that no profit has been assigned to Nevada.

Step #2: Apportion One-Third Based On Property

Another one-third of your income--$100,000 in our example--gets apportioned to the states where you operate based on the property you own in those states. Some complications exist when you talk about property. In many states, rented or leased property factors into the equation based on goofy little formulas.

To return to our example of the Nevada LLC, suppose that the LLC only owned property in Washington state. In this case, then, $100,000 of the LLC's business profit gets assigned to Washington.

Do you notice how none of the Nevada LLC's profit has been assigned to Nevada yet?

Step #3: Apportion One-Third Based On Sales

The final one-third of your income, that last $100,000 of profit, gets apportioned to the states where you sell your product. This "state of sale" can get very complicated. States and taxpayers frequently argue about where a sale occurs based on things like the seller's location, the buyer's location or where title transfers.

But let's not dig deeply into that detail. Let's just assume that your firm's sales are evenly split between five states: California, Oregon, Washington, Arizona and Nevada. In that case, the $100,000 of profit allocated based on sales is evenly split among the five states, with $20,000 going to each of the five states. That, of course, means that only $20,000 of the profit gets allocated to Nevada.

The Reality Sandwich

Suffice to say, the business owner who runs his business as a Nevada LLC or corporation may not get the tax effect that he or she wants. With the example numbers used in this article, only a small portion of the profit gets allocated to Nevada and, thereby, escapes taxation.

New York LLC formations expert and tax accountant Stephen L. Nelson, CPA is an accomplished author and former adjunct tax professor at Golden Gate University.
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Title Annotation:Headline
Author:Nelson, Stephen L.
Publication:Business Credit
Geographic Code:1U8NV
Date:Oct 1, 2006
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