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As a small business owner, you may have questions about where’s the best place for you to incorporate or organize your business. After all, just because you operate your company in one state doesn’t mean you have to incorporate or organize your business there, as well. Entrepreneurs looking to incorporate their corporations or organize their limited liability companies (LLCs) in the U.S. can do so in any of the 50 states—regardless of whether they intend to set up formal business locations there.
Many business owners are pushed into forming their companies in specific states to take advantage of corporate and LLC tax benefits that certain states offer. Entrepreneurs of corporations, for example, are often advised to set up C-corporations in Delaware, while founders looking to set up limited liability companies are often told to do so in Wyoming or Nevada.
But just because other business owners are incorporating or organizing their businesses in these states doesn’t mean you should follow suit. Although Delaware, Wyoming, and Nevada can all be excellent options for incorporating or organizing your business, depending on your goals, there are some situations where doing this would not make sense for business owners. Here are four scenarios where this could be the case.
If you’re looking to open a new storefront or office in a state other than the one you initially registered in, chances are you’ll need to follow the same registration processes that you would need to had you incorporated or organized there in the first place. The only difference is that you’d now have to file paperwork to register as a “foreign” business entity—which includes both international businesses and out-of-state U.S. businesses.
Depending on the business you’re registering and the state you’re looking to open a location in, this can mean added costs and hassles. New York, Arizona, and Nebraska, for example, require LLCs to publish notices in news publications for a set period after filing their articles of organization.
Under New York’s rule, if you want your foreign LLC to conduct a business in New York state, you need to run notices in two newspapers—one daily and one weekly—in the county where you plan to have your LLC’s office. These notices must run for six consecutive weeks, starting within 120 days from the date you filed your initial application to do business at the New York Department of State. The county clerk is tasked with selecting the newspapers, but this means that business owners who want to operate in the New York City metro area could be required to run costly notice campaigns in newspapers like the New York Times, the Wall Street Journal, or the New York Post.
Foreign LLCs that fail to do this might not be able to obtain important vendor licenses or have the ability to sue in New York courts. In other words, a New York-based business that plans to file initial articles of organization in Wyoming or Nevada won’t be able to avoid this requirement.
In certain parts of the country, out-of-state companies face the same tax consequences that in-state companies do—assuming they both do business in that state. Consider the way California taxes domestic and foreign S-corporations. Under federal law, S-corporations are considered “pass-through entities.” This means that—much like LLCs and partnerships—their income isn’t taxed twice at the organizational and shareholder levels. Having an S-corporation, in theory, is supposed to give owners the ability to leverage the benefits of pass-through taxation without sacrificing the liquidity and deductions that come with being a S-corporation. This is not the case in California. Domestic S-corporations that are incorporated there need to pay a 1.5% tax on their corporate income in addition to taxes on their shareholder dividends and earnings.
Delaware, on the other hand, exempts S-corporations from the 8.7% tax it levies on business that specifically transact within the state. Still, your Delaware-incorporated S-corporation won’t avoid the California S-corp tax—along with the state’s $800 minimum franchise tax—if your business is commercially domiciled in California, or if your sales to California residents exceed the lesser of 25% of your total sales or $500,000 in total sales. Out-of-state LLCs, including Nevada LLCs and Wyoming LLCs, are not immune to California reporting requirements, either. They could be eligible to pay California’s franchise tax and annual LLC fees if they meet certain requirements.
If you’re looking to take on outside investment, chances are that you should incorporate in Delaware. There’s a reason why more than 60% of Fortune 500 companies are incorporated there: Delaware not only offers competitive corporate tax benefits, but a deep body of corporate case law that allows investors, shareholders, and business owners to quickly settle or otherwise resolve business-related disputes.
Creating a Delaware C-corporation also comes with international perks, as well. If you regularly conduct business in Canada, for example, you can use an incorporation strategy known as the “Delaware Straddle” to set up sister Delaware and Canadian corporations consisting of the same shareholders. This structuring tactic allows you to not only leverage Delaware’s tax benefits and case law, but also Canada’s generous government grant programs.
While these may be attractive perks for many companies, pursuing incorporation in Delaware may be an unnecessary step if you’re not looking to become a publicly traded company, entertain outside investments, or service a broad national or international audience.
Even though you’re not required to set up your headquarters or a retail location in the state where you plan to incorporate or organize, you must maintain some sort of physical presence in that state in order to accept service of process in the event of a lawsuit. While working with a registered agent is a relatively affordable way for you to meet this requirement—reputable agents can cost anywhere from $100 to $300 per year—you’ll also likely be responsible for multiple state franchise fees, LLC entity payments, and business entity tax reporting requirements.
Because companies are also considered domiciled for legal purposes in both the state where they’re incorporated and the state where they maintain their principal place of business (which usually is where you’re headquartered), you could also be sued in the state where you’re organized or incorporated. This can raise a broad array of litigation-related headaches if the state where you’re incorporated or organized is far away from the state where you actually have offices and conduct business. In this case, it may make more sense from a logistical perspective to incorporate or organize in your business’s home state instead of filing this paperwork in a different state.
You have likely heard advice that you should incorporate or organize your small business in a state like Delaware, Wyoming, or Nevada. While it’s true that these are good options for many business owners, they might not necessarily be the best move for your business. And there are some cases where incorporating your business outside your home state can actually cause you to face annoying logistical problems or expensive tax consequences. Before making any final decisions on where you organize your small business, it’s worth seeking the advice of an experienced attorney who you trust.
This article has been prepared for informational purposes only and not for the purpose of providing legal advice. You should contact your attorney or accountant to obtain advice with respect to any particular issue or problem.