Choices, choices, choices… location, location, location. This is a common question for founders – “I have 50 states to choose from! Where should I form my business?!”
Form Your Business Wherever Will Cause You the Least Hassle
Ultimately, this is your decision. There are no secret “best” places to form your business, unless of course you are planning on raising half a billion dollars in your first three years. Realistically, assuming large-scale capital raising isn’t in your immediate future, it makes more sense to form your business in the state in which you will be operating the most. This is because you reduce the amount of paperwork, taxes, and fees by doing so.
Let’s use an example to illustrate this. Jon Snow has just started his graphic design business in San Diego, CA and wants to form an LLC called Winterfell, LLC. So, Jon forms Winterfell, LLC in California and uses himself as a registered agent. Jon must now pay California’s annual minimum franchise tax of $800 per year, and must submit required information filings to the state. Now, let’s change the hypothetical up a bit. Jon’s friend tells him that every successful company is formed in Delaware, so Jon forms Winterfell, LLC in Delaware but wants to operate in California. Now Jon needs to register his LLC in California as a foreign entity, maintain registered agents in both California and Delaware, pay Delaware and California an annual minimum franchise tax, and file information filings in both states.
Thus, forming your business outside of the state in which you want to operate really just means more things to forget to do, which could land you in some serious hot water with either or both of the state agencies.
Can I choose to form my business in the state with the lowest taxes?
As you may already know by now, different states have different levels of business taxation. You could indeed choose to form your business in the state with the lowest level of business taxes, but it’s not a good idea. The laws of the state where you incorporate will govern your business. But this isn’t the only state that matters. Where you do business also matters.
Any state you operate in will require you to pay sales or revenue tax on all transactions originating within its borders. These states will also require you to pay their annual franchise tax—regardless of whether or not you incorporated there. So, while it may seem like you can fool the system by forming your business in whichever state is the US equivalent of the Cayman Islands, you will actually end up paying two sets of taxes.
Do I have to register in states other than my state of incorporation?
Yes. As we mentioned above, if you “do business” in other states to a significant enough degree you must register as a foreign business in that state. Even though each state interprets “doing business” differently, as a good rule of thumb, you are considered to be “doing business” in any state where you earn profits, or any state where you are physically located. As such, you must register in each of these states as a foreign corporation (failure to do so will subject your business to fines and may even subject your directors and officers to personal liability).
Once registered as a foreign corporation, the state will require you to file an annual report, pay filing fees and obtain a registered agent within the state—essentially the same requirements as if you formed your business in that state. The state will also require you to pay any annual franchise tax and tax on any income made within the state’s borders.
Ok, so where do I incorporate?
Your aim is to incorporate where you will primarily transact business. If you conduct business only in one state, form your business there. Doing so eliminates the need for your business to register as a foreign corporation or LLC in other jurisdictions and thereby eliminates extra fees and reporting requirements.
To get a better sense of where to incorporate, answer the following questions about your business:
- Where do you plan on regularly transacting business? Where will the principal place of business be located?
- Will you regularly conduct business in more than one state?
- Is there a reason to form your business in a state other than your home state?
- Are there special tax matters to consider? (Contact a tax professional if you think your business would significantly benefit from a particular tax measure in one jurisdiction over another.)
Why have I heard that Delaware is the best state to incorporate in?
Probably because Delaware is the best state to incorporate for large, public corporations. These organizations benefit from Delaware’s corporate laws because
- Separate Court. Delaware’s Court of Chancery operates as a separate court, dedicated to resolve business disputes. As a result, litigation in Delaware is resolved more quickly than other jurisdictions.
- Risk Management. Large public companies incorporated in Delaware can more efficiently manage large-scale risk since Delaware’s well-developed body of corporate law allows them to better plan their affairs. Similarly, these large corporations can more accurately predict how litigation would play out if they were sued since judges rather than juries decide these cases.
- State income tax. Delaware corporations do not pay a state corporate income tax if they do not transact business there (but all companies must pay an income tax in the state where it does transact business).
Small businesses rarely, if ever, worry about complex business litigation. As such, incorporating in Delaware provides no advantage to small businesses when compared to other jurisdictions.
By: Jenna Macek – 11/07/16
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