When entrepreneurs are ready to launch a business, among the numerous questions to consider is where should you incorporate your company. Some choose to keep things simple by incorporating or forming an LLC in their home state, while others opt for more "business friendly" states and incorporate in Delaware, Nevada or Wyoming.
Choosing the state of incorporation can be tricky business, since each state differs in terms of fees, taxes and other details. It’s only natural to want to find the lowest cost and best option for your situation. If you are launching a business in 2015, here’s a breakdown of some of the key differences across some of the most popular states for business formation:
1. Formation fees.
When you form a corporation or LLC, you need to pay a one-time filing fee to the state’s secretary of state office. Arkansas, Colorado, Hawaii, Iowa, Oklahoma and Mississippi all boast the lowest corporation formation fee at $50. It costs $310 to incorporate in Texas. Connecticut currently has the highest corporate formation fees at $455.
Keep in mind that this is a one-time fee and shouldn’t have a significant impact on your bottom line over the lifetime of your business.
2. Annual fees and filings.
Most states charge an annual fee to maintain an LLC or Corporation. You’ll typically be required to submit an annual one-page report to the secretary of state's office, along with a filing fee. Sample filing fees are: Nevada $325; Delaware $225 for corporations/$300 for LLCs; Wyoming $52; South Dakota $50; New York $9; and California $21. Currently, Ohio and Alabama are the only two states that do not require some kind of annual or biannual report from corporations.
3. Franchise taxes.
Many states impose franchise taxes in place of, or on top of, the annual report filing fee and state income taxes. A franchise tax is basically levied by the state on corporations and other business entities for the privilege of being incorporated or registered to transact business in the state.
The method for calculating franchise taxes varies by state. For example, California charges an annual franchise tax based on income with a minimum tax of $800 per year, even if your business is losing money. Delaware bases its franchise tax on the number of shares and par value, meaning the amount isn’t significant for a small company with few assets and stockholders. Nevada and Wyoming have no franchise tax at all.
3. Legal and court system.
There are reasons why 64 percent of Fortune 500 companies are incorporated in Delaware, not least being Delaware has a separate court to resolve business disputes that lets judges decide instead of juries. Cases are often resolved more quickly than in other states. Many business owners prefer their case’s fate be determined by a judge who is experienced in business matters, rather than a jury.
However, this advantage typically doesn’t apply to small businesses that will never have to contend with complex business litigation.
It’s important to note that many investors are familiar with Delaware corporate law and will request and/or require a company to be a Delaware entity prior to investing in them. If you are seeking venture capital financing, it may be easier to start as a Delaware corporation in the first place.
5. State corporate income tax.
Six states levy no corporate income tax at all: Nevada, Ohio, South Dakota, Texas, Washington and Wyoming. However, Ohio, Texas and Washington have gross receipts taxes, which is a tax on the gross company revenues. Additionally, of these tax-friendly states, Nevada, Wyoming and South Dakota have no state personal income tax.
To be sure, the lack of state corporate and personal income tax is a huge advantage for those businesses that are based In Nevada, Wyoming and South Dakota. However, these advantages do not apply to a business located in another state. For example, if your business is located and operates in California, you can’t avoid paying California state income taxes by incorporating in Nevada. You will be subject to the tax laws of whatever state you operate in.
The cheapest state to form a corporation won’t necessarily save you money in the long run. That’s because if your business is incorporated in one state and then is located and does business in another state (aka where you live), you will need to register to conduct business in your home state and end up paying those state filing fees and taxes anyways.
In short, a company will end up paying corporation maintenance fees and taxes wherever it conducts business, so there’s not much advantage in choosing a state of incorporation based on the filing fees or taxes alone.
As a rule of thumb, if your business has fewer than five shareholders, it’s best to keep things simple and incorporate or form an LLC in your home state.