[philiphodgen]

This is what I do in my day job. (International tax lawyer).

1. If you're in the USA the game is to escape State income tax. You are pretending that your business operates out of a Post Office Box in Las Vegas and therefore you shouldn't pay income tax in California (for example)? Good luck. It's a dead loser.

Don't waste your time. Especially when you're a startup and have no profits to speak of anyway.

2. Again if you're in the USA, on the merits of using Delaware or Nevada compared to your own state to form a corporation or LLC . . . .

Forming your company in Delaware or Nevada and operating your business in California (for example) just adds overhead to your business. Unless there is a compelling reason to do otherwise, use the corporate law for where you are. Keep it simple. Look at Google. They started as a California corporation and later reincorporated in Delaware.

3. Onward to your second paragraph. Again if you are in the USA and you want to think about taxation of your business, think about where the humans are. That will give you a clue on how the business will be taxed. Pretend you are selling equipment leasing deals over the phone and making a commission on each deal you made. Who would want to tax you? Yep -- the state where your ass sits while yapping on the phone. There's nothing mystical/magical about tech stuff.

There are plenty of things you can do tax-wise that are cool. E.g., I have a guy who has a California corporation that makes money this way and he sits in the Caribbean and the first $192K of net profit every year is tax-free (half to him, half to his wife who is on salary). No State income tax to him because he's not living in California. Yeah, the 1.5% S corporation tax applies. He's living well.

4. Throw me a few more details and I'll give you more concrete suggestions.

/Phil

[elai]

If I'm a Canadian who lives outside of america but wants to have an office in the bay area so I can hire local bay area people and have people be close to the area for meetings and what not. The head office isn't in america and the bay area office just pays developers to make software and hold business meetings. I and other staff possibly are in the head office in singapore, labuan, panama or wherever else. Will there US be taxation of the corporations profits then?

[philiphodgen]

My default starting point for something like this would be to suggest a California corporation. Put your local people in it. Engineer the net profit of the California company. :-) That keeps your U.S. and California tax bill low.

How is that done? Google alert: "Transfer Pricing" is the game. Control the way in which sales are made so whatever you earn in California is offset almost entirely by operating expenses.

This is a point of obvious contention between the tax people and businesses. The tax people don't want you to artificially manipulate your business affairs to eliminate tax. There has to be an arm's length approach to how you do this.

It gets worse. Assume you have operations in the USA and Canada and India. Each country's tax collector would (logically) like to have you earn maximum profit in that country, and bugger the other places. So they'll pull out the local transfer pricing rules and say that you are artificially understating profit in that country. Now you're at risk of having the same $1 of profit taxed in two or three countries.

Yes there are ways to prevent this, and ways to fight back. But this gets expensive in lawyer and accountant fees. And buying expert opinions from economists about the esoteric meaning of "arm's length" in your particular business, etc.

[gilaniali]

Fantastic Answer. Heres a few more what-ifs.

When I said tech startup, i meant companies developing web applications that people pay for. So for example, if people use DropBox or Basecamp, and there is no guy making a commission, then you can only tax the company in which ever state it is in?

Also, what about incorporating abroad but having your customers in the US?

[philiphodgen]

First part. If your company has a single place of business and you're selling all over the USA, then the only State that will tax your profit is the state where you have your office. That's a good first principle.

There are tons of exceptions. California thinks that if you come to a trade show for "too many days" in a year that is enough to cause presence for taxation for a non-California business. Every state tries to find some weasel-ass way to hook you and claim the right to tax your business. So be careful.

When you're thinking about doing business multinationally, the first thing to remember is that the U.S. tax law in the international tax world is written with two basic assumptions in mind:

1. All companies are of the size of Mitsubishi or larger, and operated by humans.

2. All humans are Colombian drug lords or worse.

You think I kid. No. The towering lunacy that is Washington DC has no bounds.

So when thinking about doing business across a border your PRIMARY concern should be paperwork costs, accounting costs, and brain damage. Your accounting costs and risks for accidentally f-ing something up will go up by an order of magnitude.

That aside, let me answer your question.

The variables in this equation are (a) the citizenship of the owners of the company; (b) the place of incorporation of the company; (c) the place of operation (might be multiple) of the company; (d) the source of the revenue (where are the customers?); and (e) the type of revenue (royalty, sale of a thing, etc.).

Starting from the simplest proposition. If the shareholders are U.S. people, a non-U.S. corporation will not affect US taxation at all unless it is a real live operating company incorporated in the place it is operating. If you're incorporated in Bermuda, for instance, you better have offices and bodies there doing the work. Otherwise the company is treated as a giant hose depositing net profit into the pockets of the shareholders.

For the Google fanatics: "controlled foreign corporation" and "Subpart F" income.

Now specifically on to your situation. When does it make sense to think of offshore corporations? You're a U.S. person starting a company and developing IP. You'll be exploiting that IP for fun and profit all over the world, eventually. If the amount of profit you're deriving from non-U.S. sources is big enough, you can create a system to defer (but not eliminate forever) the U.S. tax until you bring the profit home to your pockets.

I wouldn't bother until you have a couple million a year of profit from non-U.S. sources. The overhead is too big.

For a non-US owner with a non-US corporation, it is fairly easy to eliminate the US income tax bite on sales:

1. Don't have an office here (Google fans look up "permanent establishment" as a general clue).

2. The sale "occurs" outside the USA. (When ownership changes hands, that's when you look for where the profit was earned. E.g., you're buying toys from a factory in China. If you own them on the wharf in China, the guy selling them earned his profit in China. If you own them as soon as the container hits the deck at Long Beach, CA, then the guy selling them to you earned his profit in USA and he's cryin' and singin' the blues.)

[gregholmberg]

>> I wouldn't bother until you have a couple million a year of profit from non-U.S. sources. The overhead is too big. <<

Is the cost of setting up these entities falling? Rising?

[philiphodgen]

The cost of entities is static.

The cost of professional services is the issue. The government lards on more and more stuff you have to do, and the penalties for mis-steps in international tax are huge. That is where the costs come in.

[davidw]

Dropbox Inc. and 37 signals Inc. are both incorporated in the United States (well, 'registered' in the later's case, as it's an LLC).

Worry about making something people want and making money at it - that's way more important than trying to wiggle your way out of taxes.

I'm not saying anything different than the path taken by ... well, pretty much everyone. Google, Microsoft, Facebook, Twitter, Oracle on down to things like 37 signals. They're all registered in the United States.

[chegra]

Which Caribbean island? I'm from Antigua; I think we are suppose to be a tax haven

[philiphodgen]

I won't say where my client lives because ahem there might be some local taxation and ahem he is there on a tourist visa. :-)

The ability to exclude income from taxation works for any U.S. citizen living abroad. The first $91,400 of earned income is free of U.S. tax. Look at Form 2555 from irs.gov. If you live in Germany you escape U.S. tax but you have to pay tax where you live, so there is no net savings. If you live in Antigua, the UAE, etc. where there is no income tax, life is good.

Warning though: you still have social security tax or self-employment tax to contend with.

[elai]

'think about taxation of your business, think about where the humans are'. What a succinct way to put it.

[_exec]

Do you have any experience with incorporating in the BVI and similar jurisdictions? If yes I think I'll be contacting you very soon :) See my post below (http://news.ycombinator.com/item?id=1801001)

[philiphodgen]

I typically use either BVI or Bahamas simply because it is fast, cheap, and efficient to set up and operate companies in those two places.

The Netherlands Antilles has priced itself out of the market (well, and as such it doesn't exist any more, does it?) and has also introduced a very European corporate income tax.

Cayman companies are a tad pricier than BVI or Bahamas.

[SkyMarshal]

Love your profile: "No f-ing Facebook." :D

[philiphodgen]

Yeah it was a dead loss to me. Even my 13 year old daughter is having second thoughts. (She is also turning in her iPhone for a Blackberry, which may or may not be a data point of interest to the smartphone manufacturers).

Twitter on the other hand has made me new friends in faraway places. Last time I was in Singapore I announced my arrival and a guy volunteered to give me the 2 hour tour. I've gone to cigar clubs in Riyadh and had a multip-person meetup in a Starbucks in a shopping mall in Dubai.

It's those human connections that make Twitter great for me.

If you're ever in Pasadena, CA -- @philiphodgen :-)

EDIT: I will be in San Francisco chairing the California Society of CPA's International Tax and Business Conference on December 7, 2010. I'll be flying up on Sunday, December 5. If you're interested in getting together for (geez I can't believe I'm saying this) free tax brainstorming shoot me an email at [e-mail].

[zackattack]

> Look at Google. They started as a California corporation and later reincorporated in Delaware.

Why did Google later reincorporate in Delaware?

Also, thanks for posting in this thread.

[philiphodgen]

I think Delaware made the Wall Street people happy. Taxwise I'm sure it makes no difference to Google.