Let’s say that you own a tomato farm in Iowa. You harvest your own seeds, grow your tomatoes in Iowa soil, harvest your tomatoes with a local workforce, and sell them at a local farmers markets. Congratulations—you own a single-state business, and you don’t need to worry about foreign qualification.
But what if you’re a startup founder who is building a platform to connect farmers to restaurants and boutique grocery markets in their region? You might be based in Chicago, but you hire engineers based in Texas, and you’re growing a user base nationwide.
In this case, you might be doing business in multiple states—and you might choose to pursue foreign qualification.
What is foreign qualification?
Foreign qualification is the process of registering your company in any state other than the state in which your business is incorporated.
US companies are considered domestic only in their state of incorporation. If your company is incorporated in Delaware, you can register as a domestic entity with the Delaware Secretary of State —in any other state, you’ll need to register as a foreign entity, or foreign qualify.
Foreign entity types include the following:
- Foreign corporation or nonprofit corporation
- Foreign limited liability company (LLC).
- Foreign partnership or limited partnership
Do you need to foreign qualify?
There’s no single answer to the question “Do I need to foreign qualify?”. In general, foreign qualification is required in any state where your company is transacting business. But laws and definitions of “transacting business” vary by state and both often leave considerable room for interpretation. For this reason, foreign qualification is ultimately a business decision, and it’s up to business owners to decide how to navigate it.
What counts as “transacting business” for the purpose of foreign qualification?
So, you may need to register to transact business in another state. That’s simple enough. Now, what counts as transacting business?
This is where things get complicated. Definitions vary, and many states choose not to explicitly define what constitutes “transacting business” or “doing business.” Instead, they might itemize activities that aren’t considered doing business. This opens up a legal gray area around foreign qualification requirements—in the event of a dispute, determining whether a company is doing business in a state falls to the courts.
That said, some states do clearly define activities that constitute doing business. To avoid penalties, it’s important to understand the law in every state where your company has business activity.
Broadly speaking, you may be transacting business in a state where your business meets any of the following criteria:
- You have employees in the state.
- You earn income in the state.
- You own or lease property in the state.
Not all states offer guidance about what constitutes “doing business,” but some itemize activities that don’t count as transacting business. Specifics vary by state, but states frequently list the following activities:
- Maintaining bank accounts
- Participating in a legal proceeding
- Conducting internal corporate affairs (such as holding a shareholder meeting)
- Conducting isolated transactions
- Holding partnership interest in a business
Here are a few state-specific examples.
Transacting business in California
California considers a company to be transacting business in the state if it meets any of the following conditions:
- It engages in any transaction in California for purposes of financial gain.
- It is organized or commercially domiciled in California.
- It exceeds California sales, property, or payroll thresholds in gross amounts.
- Its California sales, property, or payroll exceeds 25% of business total.
Because businesses with on-the-ground activity in California will meet one or both of the first two points, the state’s sales, property, and payroll thresholds are primarily used to determine business activity for remote businesses (who may earn income, own property, or retain employees in California without meeting either of the first two criteria).
Transacting business in NY
Unlike California, New York does not set clear parameters around what constitutes doing business in the state. Official guidance reads, “The New York Department of State does not give opinions as to what activities constitute doing business in New York State for qualification purposes.”
Further insights derive from case law. The Department of State cites the decision in Cummer Lumber Co. v. Associated Manufacturers Mutual Fire Insurance Corp., which determined that an organization is transacting business in the state if
- Activities that exhibit local or intrastate character are permanent, continuous, and regular, and
- Those activities are vital and essential to the organization’s business.
According to this decision, if an organization’s activities in New York are incidental to business operations, the business does not need to qualify—if they are vital, essential, and ongoing, it does.
Transacting business in Texas
Like New York, Texas does not define or list activities that count as “transacting business.” Instead, Texas lists 16 activities that are not considered transacting business. This list includes the following:
- Maintaining or defending an action or suit or an administrative or arbitration proceeding, or effecting the settlement of such an action, suit, or proceeding or a claim or dispute to which the entity is a party
- Holding a meeting of the entity’s managerial officials, owners, or members or carrying on another activity concerning the entity’s internal affairs
- Maintaining a bank account
- Maintaining an office or agency for transferring, exchanging, or registering securities the entity issues, or appointing or maintaining a trustee or depositary related to the entity’s securities
- Voting the interest of an entity the foreign entity has acquired
- Effecting a sale through an independent contractor
- Creating, as borrower or lender, or acquiring indebtedness or a mortgage or other security interest in real or personal property
- Securing or collecting a debt due the entity or enforcing a right in property that secures a debt due the entity
- Transacting business in interstate commerce
- Conducting an isolated transaction that is completed within a period of 30 days and is not in the course of a number of repeated, similar transactions
- In a case that does not involve an activity that would constitute the transaction of business in this state if the activity were one of a foreign entity acting in its own right, exercising a power of executor or administrator of the estate of a nonresident decedent under ancillary letters issued by a court of this state or exercising a power of a trustee under the will of a nonresident decedent or under a trust created by one or more nonresidents of this state or by one or more foreign entities
- Regarding a debt secured by a mortgage or lien on real or personal property in this state, acquiring the debt in a transaction outside this state or in interstate commerce, collecting or adjusting a principal or interest payment on the debt, enforcing or adjusting a right or property securing the debt, taking an action necessary to preserve and protect the interest of the mortgagee in the security, or engaging in any combination of transactions described by this subdivision
- Investing in or acquiring, in a transaction outside of this state, a royalty or other non-operating mineral interest
- Executing a division order, contract of sale, or other instrument incidental to ownership of a non-operating mineral interest
- Owning, without more, real or personal property in this state
- Acting as a governing person of a domestic or foreign entity that is registered to transact business in this state
How to foreign qualify: 4 steps
- Check the availability of your business name
- Obtain a registered agent
- Obtain a Certificate of Good Standing
- File your application
Once you’ve decided to foreign qualify in a state, you’ll need to go through the foreign qualification process. Although specific requirements vary by state, these four steps apply in most cases.
1. Check the availability of your business name
If your business name isn’t available in a state where you need to obtain foreign qualification, you’ll need to choose another one (known as a fictitious name). Some states will require you to file a certified resolution and pay additional filing fees to register under a fictitious name.
2. Obtain a registered agent
A registered agent is an individual authorized to receive legal documents and official communications on behalf of your company. You’ll need to obtain a registered agent in a state to qualify there.
3. Obtain a Certificate of Good Standing
Most states require you to demonstrate that your business exists and is in good standing with your state of incorporation in order to obtain foreign qualification. To verify this, many states require a Certificate of Good Standing, a document verifying that your business exists, is compliant with the laws of your incorporated state, and is up to date on taxes. You’ll request a certificate from your incorporated state’s Secretary of State and submit it to the state in which you intend to qualify.
4. File your application
Once you’ve gathered your materials, you’re ready to apply for foreign qualification. Consult the relevant Secretary of State’s office to locate the application, typically called an Application for Certificate of Authority or a Foreign Registration Statement. The Secretary of State will also provide details about filing fees and additional application requirements. You may need to provide additional business information such as your business’s date of incorporation or formation, principal address, and number of authorized shares (if applicable).
After you have foreign qualified
After you obtain foreign qualification, you’ll need to maintain compliance in the state where you’ve registered while also maintaining good standing in your incorporated state. Here are a few things to keep in mind.
- Maintain compliance as a foreign entity. Specific compliance requirements will vary depending on state law and your activities there, but in general, you’ll want to be sure to pay any taxes that you owe and abide by all applicable state laws. Employment laws regarding things like paid leave, required insurance, and harassment training often vary from state to state. You’re responsible for adhering to employment laws in all states where you are registered.
- Maintain good standing in your incorporated state. To maintain good standing in your incorporated state, keep up with all state and local business fees, licensing, permits, and business regulations. You’ll also need to continue to file taxes on time and file an annual report if required by your state.
Foreign qualification vs. incorporation out of state
Incorporating in a state other than the state in which your business is headquartered is known as out-of-state incorporation. Instead of foreign qualifying, some business owners pursue out-of-state incorporation in every state where they conduct business.
The critical difference between these approaches is that incorporating your business in multiple states creates a separate legal entity in every state, and obtaining foreign qualification does not.
The main disadvantage of out-of-state incorporation is that you’ll need to complete corporate compliance tasks for multiple entities. If you are incorporated in five states, as an example, you’ll need to hold five separate shareholder meetings, file five annual reports, and maintain five sets of bylaws.
Out-of-state incorporation also provides total separation of liability between entities, which can confer significant benefits under some business circumstances. As an example, your Nevada-incorporated business can’t be held liable for the actions of your New York-incorporated business or required to pay off its debts.
Need help foreign qualifying? Mosey’s compliance platform can do this and more. We automate setup, provide tools to identify and manage ongoing compliance, alert you when requirements change, and provide a unified source of truth. Mosey is agnostic to the payroll provider or tax vendors you use, making it a good fit for startups looking to hire their first out-of-state employees, or scaling businesses operating in many locations at once. Want to learn more? Schedule a demo—our team is excited to meet you.