The last two years have found corporations across the world struggling to adapt their operations to meet the shifting demands of a global pandemic. In the face of persistent economic uncertainty, some businesses may even choose to stop doing business in a state where they have qualified as a ‘foreign entity’ – or a company that has registered to do business in a jurisdiction other than its domestic or formation state. While reducing the size of an operational footprint may ultimately be the right choice for a business, a company could potentially face a number of tax, regulatory and reputational consequences if the ‘withdrawal’ process is not meticulously executed.

Growing pains 

But why might an organisation need to withdraw from a state in the first place? Many companies may start out small, doing business in a single jurisdiction before success gradually expands and carries their operation across borders. The decision to expand into a foreign state can in and of itself be an intricate and detail-oriented process that necessitates compliance with each foreign state’s corporation or LLC law. 

Generally, those obligations include filing an application for authority with the secretary of state (or with whatever the business entity filing office in that state is called), while also appointing and maintaining a registered agent for service of process. Companies may also be called upon to file an annual or biennial report and pay a franchise tax or fee.

But despite all of the preparation involved in expanding a business into a foreign state, the outcome isn’t always sustainable long-term. As the economic uncertainty around the pandemic has illustrated, fortunes can quickly change. Circumstances – financial, strategic or otherwise – may dictate that the wisest course of action a business can take is to begin reducing its footprint by shutting operations in a given state. 

To remain qualified or not?

Depending on the state involved and the future of the company in question, deciding whether to remain qualified or to withdraw can be complicated. For example, a corporation or LLC is not generally required to notify the secretary of state’s office if or when it decides to cease operations in that jurisdiction. A business may even choose to remain qualified when it is not actively conducting business in a state – provided it is willing to put in the effort. Bear in mind that so long as a business continues to qualify, it must also continue to file its annual report, maintain its registered agent and stay in compliance with any other state laws. 

Putting an end to those obligations requires corporations or LLCs to undertake a statutory procedure generally known as ‘withdrawal’, or ‘cancellation’ in some states. To successfully execute this process, companies typically must file an application – known in many states as a ‘certificate of withdrawal’ – and supply payments for all fees and taxes due. Any other reports owed should also be filed. 

Tax concerns

Some states may require that a company go a step further in proving that it is up to date on all tax payments and report filings. Businesses can obtain a ‘tax clearance’ – or proof that they are up to date on all taxes and reports owed – by sending a request to the state tax office. While this may sound relatively simple, corporations or LLCs still need to plan accordingly. Obtaining a tax clearance can take anywhere from weeks to several months, and in the interim businesses will need to continue paying taxes and filing annual reports. 

However, it is not only taxes that a company might have to consider following the decision to cease operations in a state. A business is also still subject to suit for causes of action that arose prior to the withdrawal – an issue that can be addressed in the body of its application for withdrawal. For example, many states require that a corporation or LLC revoke the authority of its registered agent and instead appoint the secretary of state as its agent for service of process for any proceeding based on a cause arising while it was authorised to do business.

Given both the expense and the number of steps involved, some companies may be tempted to forego the withdrawal process altogether, which is only viable if they continue to honour key deadlines for filing taxes and mandatory reports. Keep in mind that states maintain the power to collect any late fees, fines or interest payments owed.  

Depending on the state statutes involved, the officers and employees responsible for a company’s tax payments or returns could also be held liable if the taxes are not paid. It is not just legal jeopardy at risk. Compliance failures could also result in damages to a company’s reputation if a corporation or LLC’s delinquent status is listed on the filing office’s public record, becoming visible to potential lenders or business partners. 

As corporations or LLCs continue to re-evaluate the scope of their operations in response to an uncertain economy, initiating a withdrawal process can often be one of a company’s best options for exiting a foreign state without jeopardising tax or regulatory compliance. Still, it is important to carefully monitor the details involved, obtaining the necessary certificates and tax clearances required in order to ensure that organisations are leaving a state without any unfinished business pulling them back.

Sandra Feldman is a publications attorney at Wolters Kluwer CT Corporation