Here's what you need to know about foreign qualification.

Most business owners tune out when they hear the phrase foreign qualification, thinking it only applies to companies incorporated outside the U.S. But the term "foreign corporation" actually refers to any business that is not incorporated in a state where it is doing business.

What is foreign qualification?

Qualification essentially means registering your corporation or LLC to do business in another state. (Sole proprietorships and LLCs are usually just required to file a DBA.) Although there are several factors involved with determining whether or not a company is "doing business" in a state, the criteria commonly includes whether the business is physically located in the state, has employees in the state, accepts orders for its products in the state, or maintains bank accounts in the state.

What's involved with foreign qualification?

States require foreign qualification as a way of keeping track of the business entities that are buying and selling within state boundaries. Since each state has different rules, you will need to check with the appropriate state government to determine the exact process you should follow. You probably won't have to maintain an office in the state, but you will be required to name a registered agent in the state. Registered agents are responsible for receiving official documents (legal and tax) for your business, and must have a physical address rather than a P.O. box.

What are the risks involved with not qualifying?

The benefits of qualifying your business are far greater than the risks involved with ignoring the requirement. Naturally, if the state discovers that a non-registered company is doing business within its borders, the company will be subject to significant fines and penalties. That alone should be enough reason to bite the bullet and register. However, failure to register has another consequence that can be even more damaging. If you are doing business without a registration, the state won't recognize your company's legal status. If your company is sued, you may be denied the right to defend yourself in court. In other words, plaintiffs can be awarded judgments against your business and there is nothing you can do about it.

Are there any other options?

If for some reason you are dead set against qualifying your company in another state, there is another option. Instead of registering the company, you could choose to incorporate your business in each state you do business. This essentially classifies your business as a domestic corporation rather than a foreign corporation in each state, and eliminates the qualification requirement. The big advantage of incorporating in each state is that it provides a liability firewall. For example, if you are sued in Kansas, the assets your company holds through its Ohio corporation are protected. But there is also a significant downside to incorporating in every state you plan to do business: Duplication. Each corporation requires its own board of directors, officers, bank accounts, tax filings, etc. – the sum of which could overburden your company's staff resources if you aren't prepared for it.