Once the decision has been made to do business as a limited liability company (LLC), one of the next decisions that must be made is: “what state is best for forming an LLC?” In many cases, business owners decide to form the LLC in the state where it will be conducting its business. Limited liability companies doing business in more than one state sometimes choose to organize in the state where their headquarters will be located. This provides a degree of convenience, but is less essential in this digital age.
However, you are free to choose to form the LLC in any state. There is no requirement that any business be conducted in the formation state or that the LLC have assets located in the formation state. There are pros and cons to both approaches, both in the short-term and in the long run.
Forming an LLC in the state where the business operates makes sense for most small businesses with a limited number of owners who do not anticipate operating in multiple states within a short period of time. Forming in the state of operations reduces the cost as well as degree of complexity and monitoring required when multiple states are involved.
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That said, the organizers may choose to form the LLC in a state other than one in which they are doing business. Owners generally make this decision to take advantage of business-friendly rules and favorable legal precedents. This is particularly true if the business will operate in multiple states and have many owners who are located in various states.
Some of the factors to consider in choosing an LLC formation state are:
- fees and filings that are required—these filings include the initial filings, annual reports and other required information reports, such as a change of registered agent;
- the degree to which assets are protected—particularly important with an LLC because the states vary more widely with an LLC than with a corporation;
- management flexibility and simplicity—some states impose more requirements on LLCs than others do; and
- tax obligations (such as franchise taxes) and, conversely, any tax incentives.
Delaware has proven to be a popular state for LLC formation. One of the reasons is because its Limited Liability Company Act is based on the principal of contractual freedom. This is an advantage because the internal affairs (such as voting rights, management structure and authority, etc.), as well as the owners’ liability for business debts are governed by the state where the business is formed, and not the state where it does business. The laws in each state are not all the same; some offer much more flexibility and protection than others. In addition, Delaware is known for having an efficient filing office and experienced and knowledgeable business entity lawyers and courts. Other popular formation states due to their business friendly laws and environment are Wyoming (which invented the LLC), Nevada and South Dakota.
If the LLC is organized in a state other than the one where it does business, it will have the initial added expense of registering as a foreign LLC in the state where it is operating. In fact, this registration should be timed to occur immediately after the initial formation—particularly is the company is already operating. So, forming in a state other than the one in which you are doing business means that you will need to file articles of organization and appoint a registered agent in the formation state. Then, you will need to feel for registration as a foreign LLC and appoint a registered agent in the state in which you are operating the company. The company will also have to file annual reports and maintain a registered agent in both states. It may also be liable for franchise tax in both states, if the states impose franchise tax, sometimes called “privilege tax,” on LLCs.
Selecting the best state for forming an LLC depends on both short-term and long-range goals of the company and the owners. Absent a sound business or tax reason to the contrary, most small business owners form in the state where the business is operating. However, it’s best to explore various options with your attorney before making a decision on where to form your business.