Business Entities: Terminating a Registration vs. Letting Them Lapse
At times, organizations may want to end a business entity registration in one or more states. To accomplish this, many organizations consider letting a registration lapse by no longer maintaining a registered agent or submitting annual reports and franchise tax returns. This decision is often rooted in an organization’s financial situation, but could also arise from temporary shifts in its operations and activity in a particular state.
Lapsed entity registrations can adversely impact an organization’s financial and operational standing. It is frequently better to maintain entities, even during periods of limited or no activity. Alternatively, each state provides procedures for properly ending the existence of an entity no longer doing business in its jurisdiction. This effectively ends an entity’s ongoing obligations and signals adherence to that state’s laws and requirements.
Below, we’ll explore the reasons why an organization might need to end an entity’s registration. We’ll cover what it means to stay in good standing and briefly review the consequences of lapsed registrations. And, we’ll discuss alternative options for organizations considering ending their entity registrations.Jump To:
- Key Terms and Terminology
- Legitimate Reasons for Ending Entity Registrations
- How (and Why) to Maintain the Good Standing of Entity Registrations
- What Happens When a Business Entity Lapses? (And Why Organizations Should Avoid It)
- Alternatives to Letting an Entity Lapse
Key Terms and Terminology
Many organizations have multiple entities within their structure. For example, an engineering firm might maintain several entities to comply with state-specific name or ownership requirements. Or, a large company may have several business units structured as subsidiary entities.
Throughout this article, we’ll refer to actions affecting individual entities (e.g., an LLC, a corporation, or a limited partnership). However, organizational management should be aware of the broader implications of a single entity lapse.
When discussing business entity registrations, accurate terminology is essential.
- An entity formed in a state is said to be “domestic” or have its “domicile” in that jurisdiction.
- The process of closing a domestic entity is known as “dissolution” and is usually considered the final step to ending the entity’s existence.
- An entity registering in a state outside the domicile is considered “foreign” to that jurisdiction.
- The process of closing a foreign registration in one or more jurisdictions is known as “withdrawal,” and the entity maintains legal existence in its domicile. Dissolution of the entity may or may not follow.
- “Transacting business” refers to having a regular or physical presence of some kind in a given state. Examples have historically included maintaining an office, employees, or ongoing commerce. In light of South Dakota vs. Wayfair, Inc., the definition has expanded to include certain online activities.
Legitimate Reasons for Ending Entity Registrations
Typically, the only legitimate reason to end an entity registration is that it no longer meets the state’s definition of transacting business. While the definition varies by state and the entity’s specific activities, typical examples include:
- No longer conducting regular business, e.g., having no active clients, projects, or contracts.
- No longer having employees.
- No longer maintaining a location, such as an office, warehouse, or job site.
- No longer needing or wanting to continue its existence as a separate entity.
Management of entities that no longer do business in a state, but remain in existence, must consider whether the change is temporary or permanent. As we’ll discuss later, maintaining registrations is often more cost-effective over the short run than closing them (and especially letting them lapse.)
How (and Why) to Maintain the Good Standing of Entity Registrations
Entities are considered legally separate from their owners. This allows the owners to do business under a different name and helps protect the owners’ personal assets during legal proceedings. By maintaining good standing, the entity continues its right to conduct business and maintains the limited liability protection of its owners. Additionally, the owners can avoid potential damage to their personal and professional reputations.
“Good standing” means that the entity has met its obligations with a given state’s corporation authority, typically the secretary of state.* This generally includes the following:
- Maintaining a current registered agent where service of process can be delivered. If the entity uses a registered agent service, this means paying the provider’s annual invoice for service. If the entity uses an individual registered agent, this means filing a change of agent form each time the representative’s name or address changes.
- Filing annual reports with the secretary of state and paying the associated filing fees. Depending on the state, this report may be due each year, every two years, or even every ten years (in the case of Pennsylvania).
- Filing state income and franchise tax returns and paying associated taxes.
- Meeting other state requirements for governance and recordkeeping, which may need to be reported on state filings (or available in the event of a state investigation).
- When no longer conducting business in the state, following the procedures to properly withdraw the registration or dissolve the entity. By doing so, the entity maintains good standing up to and including the time the state officially records the filing.
Note, even if the corporation or LLC has no income, even for a short period of time, these ongoing obligations apply.
* Organizations may have other tax, licensing, and permit obligations with other agencies. These are not covered in detail in this article, but are covered in our Business Compliance Guide.
What Happens When a Business Entity Lapses? (And Why Organizations Should Avoid It)
Organizations should seek to preserve their credibility with clients, vendors, lenders, and other stakeholders. They can achieve this, in part, by keeping their entities in good standing for as long as they do business. As the name suggests, a “lapse” occurs when an entity falls short of its obligations in a given state.
Most lapses are preventable. The vast majority of entities will not experience the escalating consequences we will mention here. However, organizations should be aware of what it means to let an entity registration lapse.
Late Annual Report Filings
A majority of entity registrations fall out of good standing due to a late annual report filing. Each state has varying deadlines based on the entity type, its date of registration, and whether it is domestic or foreign. With so much complexity, it is hardly surprising for organizations that manage annual reports on their own to miss a deadline.
In many states, late annual reports can incur costly late fees. For example, Florida assesses a $400 late fee on LLCs and corporations that file reports even a single day late. However, an organization can quickly restore its good standing if it makes a concerted effort to file the report and fee within a few days or weeks following the deadline.
The best way to maintain annual report compliance is to engage a solution to track and file annual reports proactively, i.e., well before the deadline in each state.
Organizations that allow an entity to lapse intentionally (or even unintentionally, such as following personnel turnover) tend to face more issues. In addition to assessing accruing late fees, states eventually take administrative or “involuntary” action against non-compliant entities. This is often known as “revocation” for foreign registrations and “administrative dissolution” for domestic entities.
If a corporation or LLC is inactive by means of revocation or administrative dissolution, it cannot legally transact business in a state. This can impact the entire organization's ability to engage with clients, creditors, and other government agencies. Generally, the owners of an administratively dissolved entity are exposed to unlimited liability and may have limited access to the court system.
A late annual report filing will not cause any of these issues as long as the organization quickly moves to correct it. On the other hand, revoked and administratively dissolved entities are more difficult to clean up. For example:
- If an inactive LLC or corporation ever wants to restore its good standing, it must follow a process called “reinstatement.” During reinstatement, the entity submits all historic filings and fees incurred during the time of the lapse. For example, inactive corporations must generally still file an income tax return. In the event of overdue tax returns and payments, the organization may be required to refile and obtain tax clearance (sometimes encompassing many years)—a costly and lengthy endeavor.
- If the state took other legal action against the entity, the organization might need to report the action with other agencies, vendors, and lenders. If the legal action is outstanding, the entity may be prohibited from operating until the action is resolved.
- Every state maintains a searchable directory of registered business entities. Delinquent, lapsed, and revoked statuses are readily visible to the organization’s clients, competitors, and other stakeholders. It is not difficult to imagine the damage this can do to the reputation of the organization, its owners, and employees.
Together, the consequences of even a single lapse can impact the organization's profitability and actually cost more than either of the following alternatives. In all cases, organizations should choose a course of action that is proactive, responsive, and which avoids lapses—unintentional or not.
Alternatives to Letting an Entity Lapse
Organizations have evolving strategies that determine when and where they must form and register entities. Rather than let an entity registration lapse, most states offer two alternatives:
Maintain Entity Registrations
In some instances, keeping the entity active may be a less costly option, especially for organizations experiencing only temporary shifts in their activities.
For example, an organization that closes an entity registration and then wishes to do business again in the future will have to either foreign qualify again or form a new entity. If the organization lets the entity lapse, it will have to go through a costly reinstatement process.
Even if the entity follows the proper withdrawal procedures, the process of undergoing foreign qualification again incurs additional professional and filing fees. This re-registration can also take several days or weeks in certain states, which can present a challenge for organizations needing a registered entity on short notice.
Instead, by keeping the entity active, the organization can still do business by any lawful means. This means the organization maintains the infrastructure to pursue business opportunities that arise on short notice.
Organizations that want to maintain their entity’s good standing generally must:
- Maintain a registered agent. If the agent is a service provider like Harbor Compliance, simply pay the provider’s annual invoice.**
- Continue to file annual reports with the secretary of state. In most states, the filing is usually highly complex, nor is the fee exorbitant.
- File tax returns and pay owed taxes. In general, entities with little or no activity tend to pay the state minimum. However, organizations are encouraged to speak with a CPA or other accounting professional for advice on their specific situation.
** If the entity simply does not want to pay a service fee invoice, it can file a change of registered agent form to update the agent of record. This also helps keep the entity in good standing.
Properly Close Entity Registrations
When an entity no longer conducts business in a state, there are procedures to close the registration voluntarily and avoid the penalties associated with a lapse. While the process varies in each state, typically, the following must take place:
- The entity must be current in its annual reporting, franchise tax, and registered agent obligations. If the entity is missing any past filings or documents, it will need to submit them before the state can close the registration.
- The entity will file formal paperwork with the secretary of state to close the registration. For foreign registrations, this document is usually known as a “certificate of withdrawal.” For domestic entities, this document is known as the “articles of dissolution.”
Both withdrawal and dissolution may require tax clearance, a separate document from the department of revenue certifying that the entity has filed all tax returns and paid all taxes.
On the one hand, entities can undo the process of withdrawal by re-qualifying. In most states, the entity receives a new certificate of authority, secretary of state identification number, and registration date.
On the other hand, the process of dissolving a domestic entity closes the entity for good. A simple procedure to undo entity dissolution does not exist in any state. Even dissolutions filed in error may not be able to be undone. In general, the organization would have to form an entirely new entity in order to resume doing business.
Closing registrations is an action that conveys a sense of finality to the state. Organizations should work with their CPA and legal counsel before making any decisions to end their entity registrations. However, by doing so, the entity will have taken the proper steps to protect its good standing and the best interest of the organization’s management, owners, and stakeholders.