Incorporating in the Home State Versus Another State
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Once you have decided to incorporate your business or form an LLC, the next step is to decide where to incorporate. You are not required to form your company in the state where it will be physically located. You can form a corporation or LLC in any state or Washington D.C.; however, there are factors you should consider when evaluating which state is best for your business.
For small businesses, two factors are typically considered when deciding where to form a corporation or LLC. The first factor is the cost of forming in the home state versus the cost of forming in another state. The second factor pertains to taxation and corporate laws governing the states under consideration.
Home State Versus Another State
Forming a corporation or LLC in the state where the business is physically located is called home state formation. Corporations and LLCs must pay filing fees to the state when the formation documents are filed. They are also subject to ongoing requirements and fees imposed by the state of formation.
Some business owners look at a state with low formation fees and think they will save money by forming their corporation or LLC in that state, even if the company is not located and does not conduct business in that state. This is not typically the case.
Companies that are formed in one state, but are transacting business in another state or states must foreign qualify the company in the other state(s). Corporations and LLCs are considered "foreign" in every state other than their state of formation. Foreign qualification registers a company to transact business in a state other than the home state. To foreign qualify, the proper paperwork, called a certificate of authority, must be completed and the necessary state filing fees must be paid. In addition to these initial filing fees, foreign-qualified businesses are subject to ongoing requirements and fees imposed by the state of qualification.
As an example, if you formed your company in Delaware, but your company was located in and transacted all of its business in the state of Florida, you would be required to foreign qualify your company in Florida.
What constitutes transacting business varies by state; however, factors often considered are whether the company has a physical facility, has employees or has a bank account in that state.
State Statutes and Taxation Requirements
When evaluating multiple options for your company’s state of formation, it is advisable to research those states' corporate or LLC statutes. Having a basic understanding of the laws of each state under consideration may help you determine if a particular state is more beneficial. For example, corporate law is one reason why Delaware is so popular with large corporations, but those same laws may not be as beneficial to corporations with only one or few shareholders.
You should also understand how corporations and LLCs are taxed by each state under consideration and also the taxation requirements imposed on foreign-qualified businesses, if foreign qualification might be necessary for your company. Does a state impose an income tax on corporations and LLCs? Does it have a minimum tax or a franchise tax?
Keep in mind that foreign-qualified companies must comply with taxation requirements both in the state of formation and the state(s) of qualification. That is a reason why small businesses with few owners often determine home state formation is best for their business. The added costs of fulfilling the ongoing and taxation requirements imposed by the state of formation and qualification often outweigh the perceived benefits of incorporating outside of the home state.
One exercise that is beneficial in evaluating taxation of one state versus another is to calculate the company's projected revenue for its first few years of existence and then evaluate the states in terms of the amount of taxes the company would be required to pay. This will help you to see if formation in one state is clearly more beneficial from a tax perspective.
As always, for questions regarding the best state of formation for your particular business, or whether your business many need to foreign qualify in another state, it is best to seek the advice of an attorney.
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