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Where
to form your Entity?
Most businesses can incorporate in any one
of the fifty states, plus the District of Columbia (unless there is a geographic
restriction placed upon the business by a particular licensing agency). Generally,
two major factors determine the optimal state of incorporation: 1) where
the entity will be operating, and 2) whether the legal benefits of
incorporating in another state are enough to outweigh the added costs
of filing as a
foreign corporation in the state of operation.
When incorporating out of state is
impractical:
For small business owners, the best place to form an
entity is usually the state
in which the owners live and intend to do business.
Often,
new businesses attempt to incorporate outside their state of operation, where incorporation fees and
income taxes are the lowest. However, there is a major drawback to this
strategy: a business which incorporates outside its state of operation will have to file
as a "foreign entity" in its home state. As a foreign
entity, the business will be subject to the taxes home state,
as well as the taxes in its state of incorporation. Even
in the case of entities with "pass through" tax status (such as LLCs,
S Corporations or Limited Partnerships, where profits flow directly to owners and are not
taxed at the entity level), incorporating out of state may subject a business
to two minimum taxes. The following are
some additional reasons why it is generally impractical for small businesses to
incorporate outside an entity's state of operation.
- In many states, the process of qualifying as
a foreign entity is as time consuming and expensive as incorporating a
domestic entity. Sometimes foreign entity qualification fees
are even higher than domestic incorporation fees.
- No matter where a business incorporates, it
must pay state income taxes in each state where it earns income.
- A corporation formed outside of its primary
state of operation will still be subject to the corporate laws in its state
of operation.
- A foreign entity will have to meet the state
reporting requirements in its state of operation as well as its state of
incorporation
When incorporating out
of state makes sense:
Two types of companies can benefit from incorporating outside
their state of primary operation: 1) multi-state companies that do business
across the country, and 2) large private or public companies. Entities with offices in more than one state may wish to incorporate outside
their state of primary operation for legal, tax or other logistical reasons. The administrative and tax expenses may be minimal if the
company is already operating in that state.
Likewise, large private or public companies may
wish to incorporate in a foreign state for legal reasons. Since larger
companies are more exposed to litigation, the benefits of more
favorable corporate laws (or interpretations of the law) may outweigh the added
tax and administrative expenses listed above.
It should be noted that incorporating in a
particular state does not guarantee that any legal action relating to the
business will be brought in that state.
Two Popular States
for Incorporation:
Larger companies usually must decide
between incorporating in one of their home states or Delaware.
Over half of the Fortune 500 companies have made Delaware their legal
home. The advantages of Delaware incorporation are described in
detail under Why
Incorporate in Delaware? Nevada
has also become a popular state of incorporation for private companies
who wish to maintain maximum shareholder privacy. While a similar
level of privacy can be obtained in many other states, Nevada provides a
low cost alternative (Nevada has no state income tax) for companies
operating in states with more rigorous disclosure requirements.
For more on Nevada incorporation, see Why
Incorporate in Nevada?
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