For most small business owners, incorporating or forming an LLC is an unfamiliar road to navigate. After determining which business type is best, the next question asked is typically where. And more often than not, this question is framed as “should I pick Delaware or Nevada?”Delaware and Nevada are hot choices for incorporation for good reason. Many larger corporations choose Delaware because it offers some of the most flexible and pro-business statutes in the country. Nevada is 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. In addition, Wyoming is rising in popularity.
To be sure, these states offer compelling advantages. However, they’re not for everyone. As a general rule of thumb, if your corporation or LLC will have less than five shareholders or members, it’s best to incorporate or form an LLC in the state where your business has a physical presence.
“Physical presence” means the state where your business is physically located, where any property owned by your business is located, where your employees reside, or where the shareholders reside. So unless your business has some kind of physical office in Delaware, Wyoming, or Nevada, it’s going to be much easier (and less expensive) for you to incorporate or form an LLC in your home state.
Let’s take a look at an example. Ned has launched a consulting business. He lives in Maryland but is thinking about incorporating in Delaware. However, Maryland happens to have rather stringent rules when it comes to bank accounts. By incorporating in Delaware, Ned’s business is considered an ‘out of state’ business for Maryland. And as an ‘out of state’ business, Ned needs to get permission to open a business bank account in Maryland. Likewise, opening a bank account in Delaware will be tough since he doesn’t have a physical presence in the state.
And the issue involves more than bank accounts. There are other potential logistical hurdles and added fees. For example, when a business incorporates ‘out of state’ (for instance, in Delaware when you live in California), there may be additional filings and fees in both the state of incorporation as well as the state where you live and run your business. These can include:
- Appointing a Registered Agent, paying filing fees, and filing annual reports in the state where you incorporate
- Appointing a Registered Agent, paying filing fees, and filing annual reports in your state of residence (i.e. where the business is physically located)
- Qualifying as a foreign corporation in your state of residence
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. Also realise that your tax liability may actually increase because you’re viewed as a foreign entity operating in the state.
As you can see, any advantages of incorporating in Delaware, Wyoming, or Nevada can be washed away with all the added fees and paperwork of trying to operate out of state. For larger businesses with more complex tax and stock situations, it still may be worthwhile to pick a business-friendly state for incorporation. However, if you’re a small business don’t fall prey to the hype over Delaware or Nevada. The benefits are really limited to larger businesses (remember the rule of thumb: more than five shareholders).
Small business owners are already contending with enough paperwork and fees as it is. There’s no reason to add more to the workload by operating out of state. If your company has fewer than five shareholders/members, the simplest route of incorporating in your home state turns out to be best.
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