Is it Worth Relocating Your Business for Tax Purposes?July 15, 2019 July 6, 2019 /
Is it worth relocating your business for tax purposes?
This question is raised often, particularly by businesses wondering if they can decrease their tax burden. More recently, it has become topical due to changes under the Tax Cuts and Jobs Act (2017), which puts a cap on state and local tax (SALT) deductions.
While the deduction cap applies to single or joint tax returns, businesses may notice a ripple effect, especially if based in a high SALT area. Business owners may find themselves paying more on their own tax returns, while key employees may also start to look at relocating, especially if it makes a significant difference.
There are a few things you need to know and weigh up before taking the relocation plunge:
Tax nexus is one of those things that has the potential to follow you around, regardless of where your headquarters are based. A nexus is the legal term meaning “sufficient physical presence” in a state for tax purposes.
Each state has its own definition of what constitutes tax nexus, but in general, physical and/or economic presence count. For example, physical presence might mean: having an office in the state, having at least one employee there, or having a warehouse or storing inventory.
Economic presence can occur when you make a certain quantity of sales (by dollar value or number of transactions) in a state. It may also count if you do business there physically, but only temporarily, such as for a trade show.
So it doesn’t matter where you physically move to; if you meet the conditions for tax nexus for your current or other states, you may still be required to pay income and sales taxes in those states. This is definitely something to have assessed before you make the move. Otherwise, you may find you get no tax savings at all.Even if moving your business to a new state, nexus for another state may apply Click To Tweet
Moving a business isn’t just about your work operations; it’s about your personal life too. Do you want to relocate? Does the new location have the amenities, activities, lifestyle, schools and other factors that you need?
Here are some other factors to consider:
- If your spouse works outside of the business, are there job opportunities for them in the new location?
- Will there be any significant change to your personal costs? For example mortgage, insurance and other living costs.
- Do you actually like the new place?
If you were to move the business but remain living in your current state, you may find that the state still considers you to have nexus with them. You usually need to establish domicile in a new state, and this process includes things like getting a state driver’s license and registering to vote.
All of this is worth researching thoroughly before making a decision—will the savings from the move outweigh the disruption?
Administrative and compliance costs
When you move a child from one state to another, they still have a birth certificate that shows the state in which they are born. A similar logic applies with any business entity. All business entity types—aside from sole proprietorships—are formally recognized under the laws of the state in which they were launched.
If your purpose is to move for tax savings, you may find that you need to go through quite an arduous administrative and compliance process in order to meet the requirements. These can be both costly and time-consuming. It’s also worth noting that there may be specific rules for your business entity type.
There are three typical ways that companies move “on paper” between states:
- File as a “foreign company” in the new state, keeping the existing company “as is.” One advantage is that this is a relatively inexpensive method; the potential disadvantage is that you’re registered in both states. You probably still have a tax nexus in the previous state and may even be subject to the business laws of that state under certain circumstances.
- Form a new company in the new state. You then have that company acquire all the assets of the old company, and you dissolve the company in the original state. This can be relatively straightforward, but it is imperative to ensure that you comply with state law on the dissolution of a business. Some states apply steep and cumulative penalties for companies that aren’t correctly dissolved.You will have to obtain a new business license and a new FEIN. This can mean that you lose any credit you’ve built up with the old FEIN.
- Merge the old company into the new company before dissolving. This preserves your FEIN and credit, but costs more to do. You need to file “articles of merger” and pay associated fees for doing so. You also need to prove that your old company is in “good standing,” otherwise you may not be able to go ahead with the merger (this includes taking care of any back-taxes owed).
In some states there is a fourth option, known as “foreign entity conversion.” The process and conditions vary among states, but if it’s available, it’s generally cheaper than a merger while allowing you to preserve your FEIN and credit.
Local business environmental factors
Another consideration before you move is the local environment and its impact on business. Lower taxes look attractive on the face of it, but what if there are other factors that negate those savings?
For example, you should look at:
- The local economy. Is it growing, declining or remaining steady? Moving into an area of decline is often not a great idea due to ripple effects from that decline.
- Local workforce. Are there plenty of well-qualified people locally if you’re going to need new employees?
- Local housing and amenities for your staff. If you’re going to move key people to the new location, will they have somewhere to live at a cost that is reasonable for them?
- Local business laws. These can vary widely from location to location, so it’s worth checking if there are any particular laws that might catch you by surprise.
- Business facilities in the new location. Are there sufficient offices or warehouses available? Will you need to build? Is there enough parking?
- Costs such as local licenses and registrations.
Impact on people
There are many “people impacts” we can discuss here—let’s begin with your current employees. Are you planning on moving them with you, or will you need to lay people off to make the move? This has obvious social and reputational impacts, potentially even upon your wider community. If you happen to be a major employer in a small location, shutting up shop can be enough to send an area into decline.
Of course, if you’re open to moving your team members, they keep their jobs but it’s still a significant disruption and impact on their lives. Families have to be relocated and social structures, routines, family and friends left behind. From a business perspective, relocating people can be a huge cost. The majority of taxpayers can no longer claim a deduction for moving expenses under the Tax Cuts and Jobs Act either.
Another group of people you need to consider are your customers. Will you be leaving loyal customers behind? Can you still keep them if you move? How will your move affect your ability to serve them? For example, what if a move means you need to raise your prices?
All of these factors need to be assessed in terms of the wider impact on the business. There’s no business without customers and you probably can’t run without your team either! Sometimes, what appears to be an intelligent cost-saving step for a business has other hidden costs associated.
Relocating your business for tax purposes may seem like an attractive prospect at first glance. There is vast variation between states and cities in terms of how taxes are assessed and what is charged. You might feel that your state is charging too much.
There is much more to a move than potential tax savings though. It’s important to take a thorough look at the broader picture and really ensure that the benefits outweigh both the risks and the costs.
We’d encourage you to talk with a tax professional about the implications of any potential move first. The most successful transitions happen when they are well-informed and carefully planned.