Converting to a California Corporation: Why Risk Getting Stung Twice?
Let’s say you’re an entertainer in Nevada who forms a Nevada corporation. When the draw of California is no longer resistible, you pack up your car and go west! What do you do with your Nevada Corporation? To operate your company in California as a foreign (i.e., out-of-state) corporation, you would qualify to do business in California. When that happens, your company becomes responsible for corporate compliance matters in both Nevada and California (which happen to be two of the highest taxed states in the nation). To continue to use your corporation without having to pay Nevada annual fees and fulfill Nevada corporate compliance requirements, the knee-jerk solution would be to “convert” the corporation to a California corporation. As explained in this article, the better choice might be to convert the corporation to a Delaware corporation.
The California Conversion Process is Straightforward
California allows foreign entities (see, Cal. Corp Code Sec. 1150 et seq. for corporations and Cal. Corp Code Section 17540.01 et seq. for LLCs) to convert into domestic California entities, as long as the state that you are exiting also permits the conversion (which Nevada allows, but New York and Tennessee do not). Conversion effectively moves the entity from one jurisdiction to another, resulting in the same exact entity existing in an alternative home jurisdiction, while ending its existence in the original jurisdiction. Once the entity is converted to a California entity, it will retain the employer identification number that was originally assigned to it. Similarly, there is no need to assign royalties, intellectual property, or any other assets because the entity maintains a continual existence.
Under California law, to authorize the conversion, the converting entity must prepare and execute a Plan of Conversion. The Plan of Conversion essentially serves as a road map for the conversion. It includes the terms of the conversion, the manner of converting the shares of each of the shareholders of the converting corporation into securities or interests in the converted entity, the provision providing for the governing documents for the converted entity to which the holders of interests in the converted entity are to be bound (Bylaws for a corporation, Operating Agreement for LLCs, etc.), any provisions that are required by the jurisdiction in which converted entity was originally organized. The Plan of Conversions must be approved by the Board of Directors and a majority of the outstanding shareholders, if it is a corporation or membership interest if it is a LLC.
Once the Plan of Conversion is approved, the converting entity must file the appropriate Certificate of Conversion or Statement of Conversion with the California Secretary of State, which will effectuate the change with the California Secretary of State. The converted entity must also notify the Secretary of State in the original jurisdiction of the change by filing the appropriate form.
But You Would Have To Be Nuts to Get Stung Twice
So, now you’re an actor with a California corporation; and you decide to move to New York. You have to deal with the exact same problem all over again. However, California does not allow domestic corporations to convert out of the jurisdiction. In other words, after moving to Nevada, you would still be obligated to pay California franchise tax and file a California tax return.
Instead of converting to a California corporation when you moved from Nevada, converting to a Delaware corporation and qualifying to do business in California would have given you the flexibility to pick up and move your corporation from state to state with relative ease. To read how this works, see Incorporated in the Wrong Jurisdiction Now What?
Delaware is a jurisdiction of choice for many reasons, including low annual fees and well founded corporate law. Small business owners are fans of Delaware for an altogether different reason – mobility. See Delaware – Jurisdiction of Choice for Mobile Generation. Let’s say your spouse can’t stand the New York winters and wants to move to Florida. In that case, you would simply surrender the right to do business in New York and qualify the Delaware Corporation to do business in Florida, a process which inexpensively maintains the continuity of your corporation. For more on this topic, watch What is the benefit of incorporating in Delaware?