The Ins and Outs of Foreign Qualification

When many business owners first hear the term “foreign qualification”, they understandably mistake it for something that needs to be done in order to conduct business in another country. While the term might be an admitted misnomer, the assumption that foreign qualifying is unnecessary is incorrect. In fact, “foreign qualification” simply refers to the process of registering your business to operate in states other than only the one that your company is formed or incorporated in.

What does “foreign qualification” actually mean?

To put it as simply as possible, foreign qualifying your company means to register it to do business in a state other than the one in which you filed to incorporate. This is due to the fact that a corporation or LLC is only considered “domestic” to a state in which it filed incorporation paperwork. For example: if you were to form a corporation in Illinois, it would be domestic to Illinois alone, and considered foreign to the other 49 states of the U.S.  

The requirements, restrictions, and processes

The first step in foreign qualifying your business is to register a document called a “Certificate of Authenticity” in the state in which you hope to conduct business. You must pay any fees associated with that process. This is typically a rather straightforward procedure. Once this step is completed, your business will be legally able to operate anywhere within the new state’s borders. However, it should also be noted there are annual ongoing formalities and fees associated with foreign qualification that you will be required to uphold and pay every year.

Is it for you?

Foreign qualification is typically a necessity if you will be conducting any type of business in a state in which your company has not formed or incorporated (i.e. you are not considered a “domestic” business).  

What does it mean to operate in a state? If you answer “yes” to any of these five questions, you meet the definition of operating in a state where you will need to foreign qualify:

1. Will you be hiring any employees in this state?

2. Do you have any financial accounts in this state?

3. Will you regularly be taking orders from within this state?

4. Do you have a physical location or presence in this state?

5. Are you primarily operating in this state, but incorporated in another?

While these are the five most common and notable reasons that would make foreign qualification necessary, it is always advisable to talk to an attorney or business filing professional to answer questions regarding these types of issues.

What happens if your business fails to foreign qualify?

Failing to foreign qualify in a state is actually a quite common problem for many first time business owners, as they either fail to realize that they need to do it, or are looking to save time or money on fees and paperwork. While this isn’t necessarily a “death sentence” for a business, it can be a costly mistake if you are caught.

First and foremost, a company that fails to foreign qualify in a state, and then is found out, will be required to pay any fees or back taxes that would have been owed to that state. There are often some fines imposed, and the usual “back tax” penalties will apply as well. Potentially more damaging to your business is the fact that a company that operates in a foreign state without qualification may be unable to defend itself in the courts of that state, either as a defendant or plaintiff.

The alternative to foreign qualification

For some large or well-funded organizations, it can be a prudent decision to incorporate in multiple states, as opposed to simply foreign qualifying.  While this opens the business up to additional paperwork, formalities, and fees, it also brings a unique set of benefits.

If a business incorporates in a number of different states, it creates a unique and separate entity in each. This creates multiple businesses that are not liable for the debts or legal missteps of the others. This can be beneficial, as it will protect the businesses in other states if one fails or faces any unexpected lawsuits. If a business simply foreign qualifies in each of the states that it operates in, the one main company will be held liable for financial or legal issues that arise anywhere.

However, as previously stated, this approach to doing business in multiple states can come at a relatively high cost. The incorporation process can be substantial, and will need to be completed in each state. This means that annual meetings, fees, and formalities must separately occur in every state of incorporation. Multi-state incorporation can also lead to accounting and tax confusion as well, although that can be handled by hiring additional business service professionals.

Swyft can help!

Foreign qualification may seem like a daunting task. Don’t worry; the experienced business professionals here at Swyft are available to help you navigate the process. Contact us today!