If you’re considering starting a business, you’ve probably wondered about incorporating in a state other than where you live. Perhaps you’ve heard that you’ll save on taxes in Wyoming, or Delaware has safer business laws, or Nevada is the best state for privacy.
Hundreds of services online will incorporate your business wherever you like. Pick a state, any state.
Since where you incorporate can have real ramifications for your company, let’s look at some of the myths and realities of out-of-state incorporation.
Reasons for Incorporating Out-of-State
Who doesn’t want a break on their taxes?
Business owners often wonder if they might save money by forming in another state. This is especially true in high-tax states. California, for example, levies an annual $800 franchise tax on all businesses, regardless of their size or income, leaving some to ponder incorporating in neighboring Nevada.
2. Business Laws
The poster child for corporate law is Delaware. The state’s Court of Chancery, which hears nothing but corporate cases, is known for its long-established business laws, speedy and efficient litigation, and a nationally-renowned wealth of case law. These factors have made the tiny state of Delaware home to more corporations than any other state in America.
Every state has its own rules for what information must be collected and made public whenever a new business is formed. Certain states—New Mexico, Nevada, Wyoming—have become popular with entrepreneurs aiming to keep personal information out of the public record. These states and others do not collect beneficial ownership information for certain entities: the names and addresses of a company’s true owners.
For some corporations, it may be necessary to incorporate in Delaware. Companies seeking outside funding may find their investors require incorporation in Delaware in order to receive their support. These investors feel more secure with Delaware’s Court of Chancery and the state’s well-defined corporate laws.
Realities of Incorporating in Another State
1. Out-of-State = Double Taxation
The irony of out-of-state formation is that many entrepreneurs do it to avoid taxation only to discover they are now required to pay taxes in both their state of incorporation and their home state.
Every state levies some form of taxation upon companies that incorporate within their jurisdiction: corporate tax, franchise tax, annual reporting fees, etc. But taxes must be paid in any state where your business has either a physical or economic nexus.
Physical nexus is easy enough to understand. Having employees, operating a storefront, or maintaining a warehouse are all examples of physical presence in a state. Economic nexus is more slippery, but the Oregon Secretary of State’s office provides a good definition: any “economic presence through which the taxpayer regularly takes advantage of [a state’s] economy to produce income.”
Forming your business in one state while generating income in another leads to only one concern: paying taxes and fees in both states.
2. Twice the Compliance
Forming your business out-of-state while doing business in your state leads not only to double-taxation. It leads to double-compliance too.
If you register in another state but intend to do business where you live, then you will have to register your company in both states. First, as a domestic entity (in the state of formation), and again, as a foreign entity (in the state where you live).
Maintaining your business in two states requires adhering to the compliance laws in both: remitting appropriate taxes, filing annual reports, appointing registered agents, etc. Failure to maintain compliance will lead to hefty fines and the revocation of your authority to do business.
3. What Benefits?
It’s important to recognize that most of the benefits to be found in states like Delaware or Wyoming only apply to a small handful of companies. The average business owner will find few practical benefits to out-of-state incorporation.
For example, Delaware’s Court of Chancery is a large draw thanks to well-established corporate laws, a tendency to fast-track business cases, and a legal system that operates smoothly and efficiently. This ease, speed, and convenience greatly benefits large corporations like Facebook and Coca-Cola, companies that expect to be sued on a regular basis.
A family-run LLC in Arizona, however, with little danger of constant litigation, will likely not see any benefit from such a system.
Bringing It All Back Home
If you already incorporated out-of-state and feel like you’ve made a mistake, don’t panic. There is a solution. A business can relocate its “home” to a different state through a process called domestication. Though not available in all states, it is allowed in most.
Domestication should not be done lightly. It requires filings in both states and includes the dissolution of your business in its current “home” state. Failure to follow domestication procedures carefully can result in your company being dissolved before it is properly established in another state, a result that leaves you with no company at all.
Once your domestication is complete, your business will reside in a single state, relieving you from paying taxes and maintaining compliance in multiple jurisdictions.
Copyright © 2023 SCORE Association, SCORE.org
Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.