If you incorporate or form an LLC, is there truly an advantage for you to do this out of state? We’ve all heard that Delaware is the best state for corporations to be based in, and there are good reasons for this. But there are also excellent reasons for staying in your home state.
You can incorporate in any state you choose, and Delaware and some other states are business-friendly states to be incorporated in. But simply doing business out of your home state always has some cost or disadvantage involved, and incorporating out of state can create even more.
Delaware’s greatest strength is its separate court system dedicated to business cases. It’s very efficient in many ways that save on legal costs. Also it has a solid body of business law developed over many decades, offering a predictability that companies can craft their legal strategies around.
The legal benefits and cost reductions of Delaware are very important to larger corporations that experience significant litigation. The state also has no sales tax, which means cost savings for merchandising companies.
Most new businesses are small. And as a rule of thumb, if your business has less than 5 employees, shareholders or partners, it may be that your company is not big enough to gain from the tax and legal advantages of incorporating out of state, compared with the downsides.
Most entrepreneurs or self-employed people start where they live in the beginning, doing business with customers and clients in their home state. Even if you have an Internet business with no borders, again it’s the question of size.
A corporation or LLC formed in one state and doing business in another is known as a “foreign” entity in the other state. The various states have their own laws that a foreign entity is subject to, as well as their own requirements for registration, annual reporting fees and taxes.
“Doing business” can be defined differently in each state also. Opening a bank account or taking orders may qualify you as a foreign entity doing business in a state.
Some states apply higher taxes to foreign entities. So, depending where you live, you could be penalized or taxed more in your principal state of business by being incorporated out of state and thus becoming a foreign entity – in your own state!
Litigation, too, happens more than we tend to think, especially over issues involving trademarks and names that often arise as companies start to operate out of their home base, or grow big enough to become more visible to other companies. Can you carry the cost of fighting a lawsuit in Delaware, versus in your home state?
As your business grows, if you have sound reasons and good tax and legal advice, you can always dissolve your entity and form a new one in a more business-friendly state.
Delaware is still the leader but several other states are chipping away at its advantages, developing their own business court systems and crafting business-friendly laws.
Delaware, Nevada and Wyoming are the top three recommended states in the US for forming a business entity, and the compelling reasons are ease of litigation and tax. States without sales tax include New Hampshire, Montana, Delaware and Alaska.
If you can actually relocate to a different state, certain states may become attractive to you based on their taxes, general economy and business friendliness. States without income tax include Nevada, Wyoming, Florida, South Dakota and Texas. Other states with generally pro-business climates include Utah and Washington.
But if your business is rooted in a home state where you live and work, where you know the economy and can learn the laws, then unless you get better advice from your accountant and attorney, you likely should stay home when it comes to forming a corporation or LLC.