In the process of forming your small business, you will make both simple and complex decisions. But one important decision is often made by default because the business owner doesn’t realize there is a choice to be made. The decision is where to incorporate your business-what state will form the regulatory hearth and home for your new entity.
Believe it or not, you are free to form your corporation in any of the 50 states or the District of Columbia. And since each of these 51 locations has its own tax structure, start-up costs and regulations, defaulting to your own home state might not be in the best interest of your business or your bottom line.
For small businesses, three major factors should impact your choice for the state of your business incorporation formation.
- The cost of formation, especially if your company will need to qualify to transact business in the home state.
- Each state’s taxation and corporate law environment.
- Does the state of your choice openly welcome new business
State of Incorporation Factor #1: Formation costs and foreign qualification
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 at the time of incorporation and are then subject to ongoing state requirements and fees.
If your company is formed in another state but transacts business primarily in the home state, it may need to “foreign qualify” in the home state. To foreign qualify, the proper paperwork-called a certificate of authority- must be completed and additional state filing fees paid.
To learn whether your company may need to foreign qualify to transact business in another state, consult an attorney.
State of Incorporation Factor #2: How Corporations and LLC’s Are Taxed
Business owners should also understand how corporations and LLCs are taxed by each state under consideration, as well as the taxation requirements imposed by the home state on foreign-qualified corporations and LLCs.
For example, find out…
- If your chosen state impose an income tax on corporations and LLCs?
- Does the state impose a minimum tax or a franchise tax?
It is often beneficial to calculate your company’s projected revenue for its first years of existence and then evaluate the states in terms of the amount of taxes your company would be required to pay.
State of Incorporation Factor #3: How Friendly is the State to New Business Owners
Some states have a well-deserved reputation for being friendly to new businesses, while others have reputations-equally well-deserved-for being difficult.
Delaware and Wyoming top the list of friendlies, while New York and California bring up the rear. Let’s compare them so you can see how different states react to new businesses.
Delaware and Wyoming
The cost to form a corporation or LLC in Delaware is among the lowest in the country. Its corporate law is among the most flexible, and there is no state corporate income tax for corporations and LLCs formed in-state (though there is a franchise tax). But before you start learning all the words to “Our Delaware,” know that many of these advantages are irrelevant to smaller businesses. There are also several indications that Delaware’s days as a haven for business may be numbered, including a recent Kauffman Foundation study placing the state dead last in entrepreneurial activity.
Wyoming is quickly becoming the go-to state for businesses of all sizes and types, with regulations that are extremely pro-privacy and taxation that is extremely low. That’s why an increasing number of analysts are now handing Wyoming the crown for most hassle-free and low-expense corporation state in the U.S.
New York and California
Both the processes and costs of incorporating and running a business in New York are famously awful. The state’s tax system is burdensome and complex, including a maintenance fee, a franchise tax, a license fee, an organization tax, and an income tax. In addition to taxes, the ongoing requirements for filings and reporting are legendary.
California’s anti-business reputation is based largely on a brutal system of taxation, including an $800 minimum income tax for both C corporations and S corporations-the highest in the nation.
When it comes to friendliness to new incorporations, the state-by-state landscape is ever-changing.
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