It’s a popular myth that it’s always best to incorporate your business in a business-friendly state, like Delaware, Wyoming, or Nevada in order to save on taxes, benefit from increased privacy, and possibly have an easier time raising capital. However, for many businesses, incorporating in these states is completely unnecessary—and it may even cost your company in the long run. Let’s break it down here, so you can make the right choice for your next business venture.
Why Some Companies Incorporate Out-of-State
While it’s true that the vast majority of Fortune 500 companies are incorporated in Delaware, that’s because Wall Street underwriters frequently require them to do so. The rules for incorporation in this tiny state make it easier for large public companies with thousands of shareholders to comply with certain securities laws. But unless you have a plan to go public in the future, incorporating in Delaware likely holds little benefits for your business.
Another reason some businesses incorporate in these states is to save on taxes. While Nevada and Delaware do not have state personal or corporate-income taxes, that doesn’t mean your business will avoid state-level taxes entirely. The fact is, if you are a resident of or doing business in a state that has state income taxes and you are operating a pass-through entity, such as an LLC or an S-Corporation, in which the tax profits or losses are passed through to your personal tax return, you must still pay those taxes in the state in which you are a resident, even if you are incorporated elsewhere.
Not to mention, if you incorporate outside of the state where you live or conduct business, you must file as a foreign registrant in the state in which you are living and operating. Such double filings can result in extra filing fees and administrative expenses that make out-of-state incorporation financially unfeasible.
In most cases, you should incorporate your business in your home state or home country, because it’s simpler, easier, and you’re probably going to need to register to do business in your home state anyway, so you can set up your business bank accounts there.
When Incorporating Out-of-State Makes Sense
That said, there are a few instances where it might make sense to set up your business entity in a state (or even country) outside your own—but these are the exception, not the rule. For example, you may want to consider incorporating outside your home state for one of the following five reasons:
1. You live in California, your business is virtual, and you are seriously considering moving out of state to avoid wildfires, draconian independent contractor laws, and sky high state income taxes. In this case, you may want to incorporate outside California.
If this is you, you might want to incorporate in Wyoming, so you can easily leave California and not have a business that is still incorporated in California and subject to California laws and taxes.
Wyoming is very easy to incorporate in, but remember, if you are paid in California and you are the owner of a pass-through business entity, you’ll still be subject to California state tax laws. There are ways around this, but they require the assistance of an experienced business attorney like us, and you should never attempt to set up your entity out of state without seeking the advice of counsel first.
2. You are 100% nomadic (or as some of our friends like to say, “yesmadic”), and you have a choice as to where you are domiciled. In this case, you may want to establish your domicile in one of the states that have no state income tax and make it easy for you to live and work there. Currently, those states include South Dakota, Nevada, Florida, and Texas.
While Wyoming is a great place to domicile your company, as it’s very friendly to businesses and easy to incorporate there, it’s not as easy for full-time nomads to establish residency there because you must live in Wyoming to get your drivers’ license, whereas you do not need to do so in South Dakota, Nevada, Florida, or Texas.
3. You are planning to raise venture capital; in which case you are likely going to want to incorporate as a C-Corporation in Delaware for a variety of reasons that you can discuss with us as part of your planning for your capital raise. And if you are seeking to raise venture capital, you are going to need the support of a business lawyer, ideally a lawyer who has worked with companies that have raised venture capital before and done so in your specific industry. Contact us, so we can support you with that, when you are ready.
4. You want the additional asset-protection benefits provided by Wyoming or Nevada state laws. Both Wyoming and Nevada provide an additional layer of asset protection called a “charging order” protection. This protection means that if you are sued personally and a judgment is obtained against you, the judgment creditor cannot take your business interests from you. Instead, the judgment creditor will only get profit distributions, when profit distributions are made, and cannot force those distributions, which can often make it more likely that the judgment creditor will settle for something less than full payment of the judgment.
5. You are not a U.S. citizen. In this case, you can set up a C-Corporation in Delaware or an LLC in Wyoming, depending on your long-term business goals and consultation with your tax strategist.
Don’t get scammed
The myth that it’s always best to incorporate in these states is so prevalent that scam artists have set up entire companies devoted to offering small business owners assistance incorporating out of state—and charging $3,000 to $5,000 for doing so. Even worse, once the unlucky owner realizes their mistake, they are forced to spend even more money paying to dissolve the out-of-state entity and set up a new one in their home state.
Don’t fall prey to such scams. In most cases, for the sake of simplicity, you’ll want to incorporate in your home state or home country. And in the instances when it would make sense to incorporate out of state, you’ll need to seek professional legal, financial, and tax guidance to ensure you do everything properly.
This article is a service of Greg Gordillo, Family Business Lawyer™. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Schedule your LIFT Session today!