Choosing where to incorporate your business can have a multitude of tax and legal consequences. Many businesses will not see a benefit in incorporating outside of their home state, because they will be subject to compliance requirements and taxes in both their state of incorporation and their home state. For this reason, many entrepreneurs should incorporate in the state where they operate. However, companies that expect to face complex litigation and those seeking venture capital funding may benefit from incorporating in a state outside of where they operate.
What makes a state “Business Friendly?”
Delaware is widely considered to be business-friendly due to its modernized corporate law and specialized courts which handle business disputes. These factors are generally more important for larger corporations with many shareholders.
Other states such as South Dakota, Nevada, and Wyoming have lower incorporation fees, fewer or lower taxes, faster incorporation, and other benefits for companies.
State taxes on corporate income
Certain US states do not charge a corporate income tax, including Nevada, Ohio, South Dakota, Texas, Washington, and Wyoming. Ohio, Texas, and Washington do charge gross receipts taxes, which are based on your company’s gross revenue. Among these states, there is also no personal income tax in Nevada, South Dakota, and Wyoming.
Businesses must pay taxes and fees in the state(s) where they do business, regardless of where they are incorporated.
incorporating in delaware
It is no secret that a high percentage of Fortune 500 companies are incorporated within the state of Delaware, even though they conduct business elsewhere.
This is because larger companies derive the most benefit from incorporating in Delaware:
- If your business is at especial risk of litigation, you may want to choose a state that has specialized business courts, like Delaware.
- Venture capitalists prefer to invest in companies that are incorporated in Delaware, because they are familiar with the state’s laws and court system. It may be wise to incorporate in Delaware if you are seeking venture capital.
- Delaware does not require companies to disclose the names of their officers and directors when incorporating, which protects anonymity.
The state offers flexibility in how you staff the leadership of your business. Leadership roles do not need to be held by Delaware residents, and one person can hold shareholder, officer, and director positions.
doing business in multiple states: foreign qualifications
Companies that do not expect to pursue venture capital funding or face complex litigation may not benefit from incorporating in a different state than the one they are based in due to the associated administrative burden.
Businesses need to apply for foreign qualification when they conduct business outside of their state of incorporation. The definition of conducting business varies based on the state. Common business out-of-state activities which may require foreign qualification include:
- Transacting business in the state above a certain dollar amount.
- Hiring an employee.
- Purchasing property.
- Opening a physical office or facility.
- Offering services, selling products, or contract bidding.
- Applying for a professional license.
If your activity in a state is limited to conducting e-commerce there, you generally will not be required to register for foreign qualification.
To qualify to do business in another state, you must register with the state’s secretary of state office or other state agency. You will also need to pay qualification fees, submit a written form with information about your company’s officers and directors, and provide a certificate of good standing from your state of incorporation. Finally, your company will need to do the following in states where you operate:
- Report and pay state income taxes.
- Report and pay state sales taxes.
- Comply with state employment tax filings.
- Designate a registered agent in the state to handle legal documentation on your behalf.
Businesses that incorporate outside of their home state will need to register for foreign qualifications in the state where they are based. These businesses will be subject to annual compliance requirements and taxes in both states. For this reason, many smaller or mid-sized companies find it advantageous to incorporate in their home state.
If your business is based in California but incorporated in Delaware, for example, you will need to apply for foreign qualifications in California. In addition to Delaware filing fees and franchise taxes, your business will be subject to the same fees, taxes, and regulations in California as if you had incorporated there.
For help navigating where your business should incorporate, which entity type you should choose, and other important legal start-up questions, please contact your trusted Chugh, LLP attorney.