Five Things to Consider When Choosing Where to Form Your Business

One of the first things you must decide as a prospective small business owner is where to incorporate your business (either called a state of incorporation, formation, or organization). This decision could either seem very simple (because your intuition tells you to form your business in your home state) or daunting (because you have 50 states to choose from). This article will present five considerations that will hopefully make your decision much easier.

Note that this general discussion applies to whatever entity you plan on forming, whether it be a corporation, limited liability company (LLC), partnership, or sole proprietorship. See Choosing the Best Ownership Structure for Your Business, Learn About Business Ownership Structures and Chart: Ways to Organize Your Business for further discussion on how to select your business entity.

Will You Be Transacting Business in Your Home State?

If you're fairly confident that you'll be conducting the vast majority of your business activities in your state of residence, then this would favor incorporating your business in that state. While definitions might vary under state law, you're probably "conducting business" in a state if you have either a physical presence (such as a property lease) or employees there.

If you conduct the entirety of your business in your home state, then you will only be required to meet the statutory requirements of that state. However, if your business operates in states other than your state of formation, then it will have to file a foreign qualification (also known as an authorization to transact business) in each of those states, which will include additional fees, periodic reports, and other administrative burdens. For example, Should my very small business incorporate in Delaware? discusses the additional costs and paperwork involved with having a Delaware corporation that also conducts its business in other states. If you intend to form your company as an LLC, then the 50-State Guide to Qualifying Your LLC to Do Business in Another State will explain the additional steps involved in filing as a foreign entity in any of the 50 states.

State Tax Considerations

Certain states stand out for their favorable corporate tax environment. For example, if your company is formed in Delaware, but does not transact any business there, then it won't be required to pay any state corporate income tax. Furthermore, non-Delaware residents are exempt from paying personal income tax or any taxes on stock that they own in their Delaware entity. Delaware's tax structure is also beneficial to companies with large numbers of authorized stock or complex capitalization structures (which might not be relevant for your small business). Note, however, that Delaware does charge a franchise tax. Each state that charges a franchise tax has a different methodology. Delaware's calculation is based on your company's number of shares and their par value, while states like California calculate its franchise tax based on your company's income (note that California charges you a minimum annual franchise tax, even if your company is operating at a loss).

The following states charge no corporate income tax whatsoever: Nevada, South Dakota, Washington, and Wyoming. In addition to Alaska, Florida, and Texas, these states also don't charge any state personal income tax. However, you should note that Ohio, Texas, and Washington levy a tax on your company's gross income (a gross receipts tax).

Many businesses view Nevada as a tax oasis because, in addition to not charging any corporate or personal income tax, Nevada also doesn't charge any franchise fees (unlike Delaware). However, if your Nevada business has any employees, it will be required to pay a quarterly payroll tax calculated as a percentage of the taxable wages paid to your employees. Wyoming somewhat mirrors Nevada in that it does not assess any corporate income or personal income taxes whatsoever, and its franchise tax cannot exceed $50 per year.

In any case, you should always take into account whether or not a state imposes an income tax on business entities either formed or qualified to do business there, and whether such state has a minimum tax or franchise tax. A helpful practice in making your decision would be to calculate your company's projected gross income for the immediate future, and then apply that amount to the taxation requirements of the various states you're considering for incorporation.

For more information on the business income taxes levied by the various states, see 50-State Guide to Business Income Tax.

Pro-Business Legal Reputation

The state of Delaware has a uniquely pro-business reputation. As succinctly stated in Where to Form Your LLC, "This state has a long tradition of being pro-business with more than 50 percent of all U.S. publicly-traded companies and about 63 percent of Fortune 500 companies incorporated in Delaware. … Delaware boasts a special business court, the Delaware Court of Chancery, with over 200 years of experience handling commercial disputes and interpreting business laws." The Chancery Court is the only business-focused court of its kind among the 50 states. While a business litigation matter could suffer significant delays in the courts of another state, it will likely be resolved much more expeditiously in the Chancery Court. The Chancery Court uses judges instead of juries, and while judges in other states deal with a variety of matters, those on the Chancery Court have a specific business law acumen. Delaware also has an extensive case law history that provides its judges, you, and your legal counsel with a roadmap regarding permissible business conduct.

Investors and Going Public

As stated in Should my very small business incorporate in Delaware?, "while incorporating in Delaware may make sense for large, publicly held corporations, it's usually not worth the effort for small, privately held corporations that do business only in their home state." If you're seeking investors for your new business, you should note that experienced venture capitalists often prefer that your business be incorporated in Delaware, simply because they're more familiar with its administrative and judicial structure. This is particularly true if your interested investors expect to realize their return on investment by having your company go public someday. The Chancery Court and Delaware's extensive case law provide an optimal legal environment for an initial public offering and can also give you guidance with respect to operating your business as a public company going forward.

Pros and Cons of Public Information and Online Filings

Public access to information and the ability to file and retrieve documents online can either be an advantage or a drawback, depending on your concerns. Florida is an example of a state that provides user-friendly online filing services that can save you time and money. In Florida, your company's articles of incorporation, articles of organization, or other relevant formation document is made publicly available online, together with your annual reports (which will include officer, director, and other information). As a business owner, you might consider such online services to be convenient because it allows you to readily retrieve your company's information free of charge on the Department of State website. This can facilitate dealings with banks, investors, clients, and so forth.

Although Delaware, Nevada, and Wyoming vary widely in their online filing services, they are all known for their limited reporting and disclosure requirements, which facilitates the ability of business owners to maintain their anonymity in public filings. This makes it easier to conceal assets and avoid lawsuits. Additionally, Wyoming allows you to protect your identity with lifetime proxies; this means that you can appoint a third party to hold your stock while you retain the right to vote the shares. Lastly, Nevada doesn't have any agreements with the Internal Revenue Service to share your financial information.