After you decide whether to form a corporation or LLC, the next step will be to decide on your formation state. The formation state — which is also referred to as the state of organization, domestic state, or home state — is the state in which you file your formation documents and the state whose corporation or LLC statute will govern your corporation or LLC.
There are a number of factors to consider when choosing the best state in which to incorporate or to form an LLC — including the cost of formation, post-formation fees, state taxation laws, and the compliance provisions of the governing statute. The costs, state taxation laws, and corporation/LLC laws vary from state to state, making some states more advantageous for certain small business owners than other states.
Choosing the state where you are located or another state
You have the option to form your corporation or LLC in the state where your business is located or where you will be conducting most of your business, but you can also choose any other state.
However, it is important to remember that if you decide to form your corporation or LLC in a state other than where you are transacting business, you will be required to qualify (or register) to do business in the state where the corporation or LLC is transacting business.
Every state other than the formation state is considered a “foreign” state. Having to qualify in a foreign state can increase your costs, as there are filing fees for qualification and in most states annual fees as well. It adds an extra level of compliance obligations.
The added costs of fulfilling the ongoing business entity law and taxation requirements imposed by two states — the state of formation and the state of foreign qualification — often outweigh the perceived benefits of forming a corporation or LLC outside the state where the business is located.
How do you form your corporation or LLC
In choosing your formation state you may want to consider how complicated or expensive the formation process is for the states you are considering. The process of forming an LLC or corporation requires the filing of a formation document (such as articles of incorporation for a corporation or articles of organization for an LLC) with the Secretary of State (or similar state agency) responsible for business entity filings.
Your corporation or LLC will also have to choose a registered agent. This is the same regardless of the state.
Some states have additional requirements. For example, the state may require publication of the formation. Although you can consider this, the formation process is not usually a deciding factor in choosing a domestic state.
The states also impose filing fees when you file your formation documents. These can vary widely from state to state. Most states also impose annual fees. Some business owners mistakenly think they will save money by choosing a state with low fees, even if their company is neither located nor conducts business in that state. But keep in mind, as we mentioned earlier, that companies formed in one state but doing business in another state must register to transact business in the state where they are doing business.
Weighing advantages: State statutes and taxation requirements
When deciding on your company's state of formation, research those states' corporation or LLC statutes to determine which is best for you. Corporation statutes differ from state to state and LLC statutes differ from state to state. A particular state you are considering may have a provision in its statute that you want to take advantage of – or a provision that you don’t want governing your company.
Also, consider how corporations and LLCs are taxed by each state you are considering. Does a state impose an income tax on corporations and LLCs? Does it have a minimum tax or a franchise tax?
Try calculating your company's projected revenue for its first few years of existence and then evaluate states in terms of the true amount of taxes required, to see if there may be an advantage.
The appeal of Delaware and Nevada
Delaware and Nevada are two states in which some small business owners choose as their formation state even if they are not located or transacting business there. They offer unique advantages for certain types of businesses.
Some potential advantages of forming your corporation or LLC in Delaware include:
- Delaware’s corporation and LLC laws are considered the most flexible in the country.
- The Court of Chancery has expertise in business law and uses judges instead of juries.
- There is no state corporate income tax for corporations that are formed in Delaware but do not transact business there (but there is a franchise tax).
- Taxation requirements are often favorable to companies with complex capitalization structures and/or a large number of authorized shares of stock.
- There is no personal income tax for non-residents.
- Shareholders, directors, and officers of a corporation or members or managers of an LLC don’t need to be residents of Delaware.
- Stock owned by persons outside Delaware is not subject to Delaware taxes.
Some potential advantages to forming a corporation or LLC in Nevada include:
- Nevada has no state corporate income tax and imposes no fees on corporate shares.
- There is no personal income tax or any franchise tax for corporations or LLCs (but initial and annual statement fees and business license fees apply).
- Shareholders, directors, and officers of a corporation or members or managers of an LLC don’t need to be residents of Nevada.
Remember, if you form in Delaware or Nevada but you transact business in another state, you will have to foreign qualify where you are transacting business. For questions about the best state to incorporate your business or form an LLC, or to determine if you need to foreign qualify in another state, consider talking to an attorney.
Ready to take the next step in launching your business? Contact BizFilings today to discuss your business formation options.