Selecting where to incorporate is one of the first steps of the business incorporation process. As you choose whether to form a corporation or form an LLC, you should also consider your options for the state in which you will register your new business. Do you want to incorporate in the state where your business is physically located (the home state)? Incorporate in Delaware or incorporate in Nevada? Consider other states?
For small businesses, two factors are typically considered when deciding where to form a corporation or form a limited liability company (LLC). The first factor is the cost of incorporating in the home state versus the cost of incorporating in another state. The second factor pertains to taxation and corporate laws governing the states under consideration.
Home State Versus Another State
When you incorporate a business in the state where the business is physically located it is called home state incorporation. Whether your business will be a C corporation, S corporation, LLC, limited liability partnership (LLP), limited partnership (LP) or nonprofit corporation, you must pay filing fees to the state when the business incorporation documents are filed. Your business will also be subject to ongoing requirements and fees imposed by the incorporating state.
Some business owners look at a state with low incorporation fees and think they will save money by incorporating in that state, even if the company is not located and does not conduct business in that state. This is not typically the case.
Companies that are incorporated in one state, but are transacting business in another state or states must foreign qualify the company in the other state(s). Corporations and LLCs are considered "foreign" in every state other than their state of formation. Foreign qualification means to register a company to transact business in a state other than the home state.
To foreign qualify, the proper paperwork, called a Certificate of Authority, must be completed and the necessary state filing fees must be paid. In addition to these initial filing fees, foreign-qualified businesses are subject to ongoing requirements and fees imposed by the state of qualification.
As an example, if you form an LLC in Delaware, but your company is located in and transacts all of its business in the State of Florida, you would be required to foreign qualify your Delaware LLC in Florida. You would then face the ongoing requirements and fees imposed by Delaware on "domestic LLCs" (meaning LLCs formed there) and by Florida on "foreign LLCs" (meaning those registered to transact business there).
What constitutes transacting business varies by state; however, factors often considered are whether the company has a physical facility, has employees or has a bank account in that state.
State Statutes and Taxation Requirements
When evaluating multiple options for your company's state of incorporation, it is advisable to research those states' corporate or LLC statutes. Having a basic understanding of the laws of each state under consideration may help you determine if a particular state is more beneficial. For example, corporate law is one reason why forming a Delaware LLC or corporation is so popular with large corporations, but those same laws may not be as beneficial to corporations with only one or few shareholders (owners) or a single-member LLC (an LLC with only one owner).
You should also understand how corporations and LLCs are taxed by each state under consideration and also the taxation requirements imposed on foreign-qualified businesses, if foreign qualification might be necessary for your company. Does a state impose an income tax on corporations and LLCs? Does it have a minimum tax or a franchise tax?
Keep in mind that foreign-qualified companies must comply with taxation requirements both in the state of incorporation and in the state(s) of qualification. That is a reason why small businesses with few owners often determine home state incorporation is best for their business. The added costs of fulfilling the ongoing and taxation requirements imposed by the state of incorporation and state(s) of qualification often outweigh the perceived benefits of incorporating outside of the home state.
One exercise that is beneficial in evaluating taxation of one state versus another is to calculate your company's projected revenue for its first few years of existence and then evaluate the states in terms of the amount of taxes your company would be required to pay. This will help you to see if incorporation in one state is clearly more beneficial from a tax perspective.
As always, for questions regarding the best state of incorporation for your particular business, or whether your business many need to foreign qualify in another state, it is best to seek the advice of an attorney.
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