Where to Incorporate Your Business

Corporate laws, tax rates, and filing requirements all affect your company's finances and bookkeeping responsibilities. The laws, rates, and requirements vary by state, with some states appearing to be more supportive of a successful business than others.

Because some states are more attractive, the state you select for incorporation (the process of officially registering the corporation) is a very important decision.

Domestic (In-State) vs. Foreign (Out-of-State) Corporations

The law distinguishes between domestic and foreign corporations. When a corporation does business in the same state as where the owners incorporated the business, it's a domestic corporation. When the owners incorporate the business in a state other than where they do business, it's a foreign corporation in the state where it operates.

You'll find a few drawbacks to operating a foreign corporation:

• No tax avoidance. When you do business in a state other than the one where you incorporated (registered) your business, you will not avoid paying taxes and registration fees in the state where you do business.
• Collateral benefits. Even though it might be more complicated to incorporate in one state and do business in another, registering a business in a different state from where you operate might come with a benefit, such as a law in the incorporating state that allows you to keep the names of your shareholders private.

You can learn more about registering in one state and doing business in another in our article on qualifying to do business outside your state.

Should You Form a Business Outside Your State?

The owners of a corporation don't have to live in the same state as where they incorporate or where the corporation provides goods or services. The owners can do any of the following:

• incorporate the business in the same state where the business operates and the owners live
• operate the business in the same state where the owners live but incorporate in a different state, or
• operate, incorporate, and live in three different states.

If you incorporate in a state different from where the business operates, you might face additional reporting requirements and taxes. For instance, suppose you want to provide services in California (where you live) and incorporate in Delaware. You'll file articles of incorporation in Delaware and also a foreign registration statement in California, along with filing fees in both states (incorporation fees in Delaware and out-of-state filing fees in California).

Incorporating out of state doesn't mean you can avoid California business licensing requirements, nor taxes on the income your business made in California. You'll be responsible for tax returns and annual reports in both states. However, you can enjoy some of the corporate-friendly business laws of Delaware, as discussed below. In contrast, if your business operates in Delaware and you incorporate in the state, you have a domestic corporation, which means you can avoid out-of-state fees and paperwork.

Domestic vs. Foreign Corporations: Choosing a Registered Agent

Every corporation must appoint a registered agent, which is a company or an individual who receives government correspondences and notifications of lawsuits on behalf of the corporation. While you can incorporate and run your business in a different state than where you and the other owners live, your corporation's registered agent must live in the state where you incorporate.

If you and the other owners don't live in the state where you incorporate, you must find a local registered agent. A number of companies offer registered agent services for an annual fee, which is a cost to consider before registering out of state.

Business Tax Rates

Before choosing a state in which to incorporate, take time to review the state tax rates that might apply to your business, as you could save money by operating in a low-tax state. As explained above, your business tax rates will depend on where you provide your goods or services, not where you incorporate. Some of the taxes that might apply to your business include:

• Corporate income tax: 44 states impose corporate income tax, which corporations pay on business income after deductions for allowable expenses. The states that don't have corporate income tax are Ohio, Nevada, South Dakota, Texas, Washington, and Wyoming.
• Gross receipts tax (GRT): Several states and many counties and cities charge GRT, which is tax the corporation pays on the company's total sales. Unlike corporate tax, corporations do not deduct expenses before calculating the tax.
• Franchise tax: Many states have a franchise tax. In some areas, it is the same as corporate income tax or GRT, and some states charge franchise tax even if your corporation did not make a profit during the year.
• Sales tax: Most states impose sales tax for all goods and services sold in the state. Unlike GRT, you can arrange your sales so that your customers pay the tax (you add the tax to the subtotal, then remit it to the state).
• Personal income tax: All owners and employees will pay taxes on the income and profits they receive from the corporation. The amount will depend on where the individuals live.
• Property taxes: Corporations that own real estate will likely pay property tax in the state where the property is located.

Filing and Reporting Fees

To keep your corporation in good standing in its state of incorporation, you must file paperwork with the state, submit annual reports, and pay filing fees. Fees vary widely by state, ranging from less than $100 to almost $500. A few states do not require corporations to file annual reports, while others charge corporations several hundred every year to file the annual report. Keep in mind if you operate in states other than the one in which you incorporated, you will likely be responsible for formation paperwork, annual reports, and filing fees in those additional states.

Business Laws

No matter where you file, your corporation will give you limited liability protection, so you will not be personally responsible for the debts and obligations of the business. That's a hefty dose of protection, and there might be more. Some states have business laws that are more favorable to corporations than other states' laws. For example, a particular state might offer flexibility, privacy, or a favorable system to handle business disputes that you won't find in other states.

Should You Form Your Corporation in Delaware?

You've doubtless heard that Delaware is a popular choice for incorporation. Delaware provides multiple advantages to business:

• Compared to other states, Delaware has fewer requirements for the board of directors (Delaware requires only one board member, and officers can live out of state).
• Corporations don't provide the names of the initial directors, officers, or shareholders on their incorporation documents, which provides a layer of privacy not found in most other states.
• Delaware has a special business court, the Court of Chancery, where judges experienced in corporate law hear disputes and settle them (having an expert evaluate a dispute is more efficient than using a judge who might not know very much about corporate law).

However, incorporating in Delaware isn't for everyone. As explained above, if your business operates in a different state, you'll face additional filing fees, taxes, and reporting requirements. For many businesses, the benefits of Delaware corporate laws don't outweigh the burdens of operating a foreign corporation.