One of the most critical choices clients face when starting a business is deciding in which state they will incorporate their company.
While many business owners opt to form an LLC or corporation in their home state, others may explore the potential benefits of registering in a different state instead. Why would someone consider that?
For one, they might have heard that certain states have lower income tax rates, laws that are more business-friendly, or lower business formation fees. I encourage you to make your clients aware that the “right” state will depend on a variety of factors.
Important Variables to Consider When Choosing Where to Incorporate:
1. Business Formation Fees
Every state requires a one-time filing fee for forming an LLC or a corporation there. The cost can vary significantly from one state to the next— some are under $100 (like Arkansas, Colorado, and New Mexico) and others are several hundred dollars (like Connecticut, Massachusetts, and Texas). In some states, like Nevada, the initial filing fee will vary according to the number of shareholders a corporation has.
Just because a state's business registration filing fee may be more than what other state's charge, it doesn't mean establishing a business in that state will be more expensive overall. The formation fee is a one-time charge, and therefore it likely won't have a significant impact on the bottom line of a business over its entire lifetime.
2. Annual Fees and Filings for Maintaining a Corporation or LLC
Many states require filings and fees on an ongoing basis to keep a business in good standing. Usually, there's an "Annual Report" (required every year, every other year, or according to some different schedule) along with a filing fee to submit it.
Examples of other possible filing and fee requirements are:
Certificate of amendment to incorporation documents when there are changes to the LLC or corporation
Change of registered agent fee
Articles of dissolution
The filings a business must submit and the costs of those filings vary by state.
3. State Corporate Income Tax
Some states levy no corporate income tax; they include Ohio, Nevada, South Dakota, Texas, Washington, and Wyoming. Ohio, Texas, and Washington impose gross receipts taxes on companies' gross revenues. Nevada, Wyoming, and South Dakota have no state personal income tax either.
Those tax advantages can make a big difference on a business's bottom line. Realize, however, that companies that are operating in one of those tax-friendly states and in other states as well will still need to pay income tax and other applicable taxes as required by those other states. For example, a business physically located and operating in California must pay California income taxes even if it's incorporated in Nevada.
4. Franchise Taxes
Some states impose franchise taxes instead of—or in addition to—the annual report filing fee and state income taxes. “Franchise” does not mean it applies only to businesses that are part of a franchise. In the states where the franchise tax is levied, it applies to corporations and other business entities (not just franchises) for the privilege of being registered to conduct business in the state.
Franchise tax calculations vary by state. In California, for example, the annual franchise tax is based on a business's income (even if a business is losing money), with a minimum charge of $800 per year.
In Delaware, the franchise tax is based on the number of shares and par value (for small companies with few stockholders and assets, the amount is usually insignificant). Other states, including Nevada and Wyoming, do not impose a franchise tax.
5. Legal System
Over half of all publicly traded companies and 66 percent of Fortune 500 companies are incorporated in Delaware. One of the reasons Delaware is so attractive to corporations is that it has a separate court dedicated to resolving business disputes, by which judges rather than juries make the decisions.
This enables cases to get resolved more quickly than in other states, and entrepreneurs have the peace of mind that someone with experience in business matters determines their fate. For smaller businesses that may never face complex business litigation, however, this might not be a significant advantage.
6. Investor Appeal
Many investors prefer to put their money into corporations that are regulated under Delaware corporate law. In fact, some might request (or even require) that a company be a Delaware entity before they invest. So, entrepreneurs seeking venture capital financing might have an easier time securing funding if they register their business as a Delaware corporation from the start.
Much to Consider!
As you can see, your clients have a lot to ponder when deciding where to incorporate. In addition to getting your advice from a financial and tax advantage perspective, recommend that they also seek the guidance of an attorney to explore the legal implications of deciding where to form their LLC or corporation.