What is the best state in which to incorporate your business?
Many questions invariably arise throughout the process of incorporating or forming an LLC for your business. By far, one of the most common questions is…where? And more often than not, the question is framed as, “Should I incorporate in Delaware or Nevada?”
These two states are hot choices for incorporation, and for good reason. Many larger corporations choose Delaware because it offers some of the most developed, flexible and pro-business statutes in the country. And Nevada is increasingly becoming a popular choice for businesses due to its low filing fees, as well as the lack of state corporate income, franchise and personal income taxes.
However, as a general rule of thumb, if your corporation or LLC will have fewer than five shareholders or members (a condition which applies to the bulk of small businesses), it’s best to incorporate or form an LLC in the state where your business has a physical presence. This means the state where your business is physically located, where any property owned is located, where your employees reside and where the shareholders reside.
In other words, unless your business has a physical office in Delaware or Nevada, it’s much easier and less expensive in the long run to incorporate or form an LLC in your home state.
Here’s one example that highlights the situation. Suppose Susan owns a soap-making business in Maryland and is considering incorporating in Delaware. However, what Susan doesn’t realize is that Maryland has rather strong rules pertaining to bank accounts. As an “out of state” business, she would need to get permission in order to open a business bank account in Maryland (even though she lives right down the road from the bank). And opening a bank account in Delaware won’t be so easy, either, without any kind of physical address in the state.
That’s just one particular (albeit very common) logistical challenge. There are countless other potential hurdles, not to mention added fees.
For example, when a business incorporates “Out of State” (for instance, in Delaware), there may be additional filings and fees in both the state of incorporation as well as the state where the entrepreneur lives and runs the business. These can include:
For the state where a business incorporates:
- Appointing a Registered Agent in that state
- Paying filing fees in that state
- Filing annual reports in that state
And then, for the state of residence (where the business is physically located):
- Appointing a Registered Agent in this state
- Paying filing fees in this state
- Filing annual reports in this state
- Qualifying as a Foreign Corporation in this state
- Paying taxes in this state
I can’t overemphasize that last point, as it is a common misconception among many small business owners that I talk to. When you’re just starting out, the tax burden can seem overwhelming. It’s only natural to be concerned about your taxes, and certainly those tax laws in Nevada are incredibly appealing.
However, just because you incorporate your business in Nevada does not mean those are the only state tax laws that apply to your business. While Nevada may not charge state income taxes for your corporation, the state where your business is physically located will come after you for those taxes sooner or later. Adding insult to injury, your tax liability may actually increase because you’re viewed as a foreign entity operating in the state.
Pretty soon, any benefits from incorporating in Delaware or Nevada are diluted when you add in all the extra fees and paperwork of operating out of state. Don’t fall prey to the hype over these business-friendly states. The benefits are really limited to larger businesses (ones with more than five shareholders).
As a small business owner, you’re already contending with enough paperwork and fees as it is. Don’t add more to your workload by trying to operate out of state. In this case, the simplest route of incorporating in your home state turns out to be best.
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