When deciding what business structure your small business will undertake, it’s important to also question where. In the US, you can form a corporation or LLC in any of the 50 states. And, the best part is you don’t need to live there, run your business there or even plan on visiting.
By registering in a state, this is basically where you file your formation paperwork. But, if you conduct business in a different state, you’ll need to register to do business in that state. This is known as a “foreign qualification,” meaning a business entity from one foreign state qualifies to conduct business in another state.
Here’s an example. Let’s say you register your business in Nevada because there are no state corporate income or franchise taxes. But, you live and work out of your home in California. To continue to do business in California, you’ll need to register as a foreign business entity there too. Your business is incorporated in Nevada, but is also registered to do business in California. This subjects you to many of the state fees and taxes in California; for example, you’ll need to pay state income taxes for any income collected there. But, you’ll still also have to pay any of your annual fees in Nevada too.
This is why I recommend that small businesses (with five or fewer shareholders) incorporate or form an LLC in the state that they live or work in. Registering in a different state just means two sets of paperwork and fees. Not worth the added hassle, since you’ll still have to follow the tax law for whichever state where you actually run your business.
You may have noticed that a lot of businesses, particularly large corporations, are incorporated in Delaware. More than half of all US publicly-traded companies and more than 64% of Fortune 500 companies are incorporated there. Why?
One key reason is that Delaware has a very business-friendly legal system. It has a separate court with judges to resolve business disputes. This means that cases often move through this dedicated court system faster than in other states. In addition, many business owners prefer to have their case reviewed and determined by a judge who specializes in business matters instead of a jury.
Another important advantage of incorporating in Delaware is that investors, like venture capital investors, are very familiar with Delaware’s corporations and corporate law. For this reason, they prefer and often require to deal with companies that are incorporated in Delaware.
But, as you can see, some of the main advantages to incorporating in Delaware don’t really apply to small businesses. If you don’t envision yourself in business court or seeking venture capital funding, then incorporating in Delaware won’t nearly be worth the effort if you don’t live or work there.
Each state varies in terms of filing fees, state income taxes, franchise taxes and more. So the question is which state is best for your business?
When you file your incorporation or LLC paperwork, you typically need to pay a fee along with it. For some states, like Colorado and Arkansas, this fee is as low as $50, while in Connecticut it’ll cost over $450. Keep in mind that this is just a one-time fee, so it shouldn’t have much long-term impact on your business.
In addition to the initial filing fee, you’ll also need to pay an annual fee and possibly franchise taxes as well. These are on top of your state corporate income taxes. For example, in California, it’s a $20 fee (LLCs) or $25 fee (Corps) with your annual report. But you’ll also need to pay an annual franchise tax that’s a minimum of $800/year (required even if your business loses money). The franchise tax is basically levied on corporations and LLCs for the privilege of being registered to conduct business in the state.
If your budget is tight, you’re probably looking to incorporate or form an LLC the cheapest state possible. Now, which state offers the lowest filing fees, annual fees, franchise taxes, and corporate income taxes? Nevada and Wyoming are often considered business-friendly states for incorporation. Both states have low filing fees, as well as no state corporate income, franchise and personal income taxes.
The bottom line is that the cheapest state to form a corporation or LLC won’t save you money in the long run. And in most cases, incorporating out of state in Delaware won’t have any advantages either. If you have a small business, keep things simple and incorporate/form an LLC in your home state.