Why It Matters Where You Decide to Incorporate Your Business by Brette Sember, J.D.

Why It Matters Where You Decide to Incorporate Your Business

When you incorporate your business, you will need to choose which state to file in. Learn the factors you should consider when making this important decision.

by Brette Sember, J.D.
updated September 25, 2020 · 5 min read

The decision to incorporate your business is just as important as where you incorporate your business.

When you form a corporation, you want to maximize your profits and opportunities to do business. As a result, many people consider forming a corporation in a state that is not their home state, believing that filing in a corporation-friendly state will save them money or allow other protections to benefit the corporation.

Many people look to Delaware, Wyoming, Nevada, and New Mexico as places to incorporate. However, choosing where to incorporate takes some research and consideration. Learn the factors you should consider when making this important decision.

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How to Choose Your Incorporation State

You can incorporate your business in any state if you are able to meet that state's requirements and are willing to file the documents and pay the fees required. Consider the following factors when deciding where to incorporate your company.

Physical Location of the Company

Where your company is physically located is an important part of the calculus in the incorporation decision. Bruce Givner of KFB Law Group in Los Angeles says this means considering "where are the employees located, where is the office located and where are the goods located."

Anonymity

You may not want your name or address to be public record. Some states require more disclosure than others and this could inform your choice of state.

Keep in mind that you will want to learn not only about the state's requirements for filing, but also the information that is required in annual filings, as well as the information the state makes public online about the companies that have incorporated there.

Costs

You will want to consider the formation costs required by the states you are considering, but keep in mind that this is not the only cost you will face. You need to hire a registered agent in that state and in some areas you may also need to obtain local licenses.

Ilya Zlatkin of Zlatkin Wong LLP in Chicago warns, "Qualifying as a foreign company within a state will carry costs on top of the ones necessary to maintain existence within the state of incorporation." Additionally, there will be ongoing fees due to the state for annual reports and for any changes made to the corporation.

Taxes

A significant cost to take into account is taxes. You'll want to compare the tax rate in the states you are considering. Shamila Ahmed of Romano Law PLLC in New York City offers some guidance. "California has an annual $800 franchise tax on all businesses. Delaware may calculate a business's taxes based on the number of authorized shares. In contrast, Nevada has no state fees on corporate shares."

Givner points out that you may have to pay taxes in both your home state and the state where you incorporate. He explains that if you are physically located in California but incorporate elsewhere, "if the business is conducting business in California, the business will have to pay tax to California at least for its California source income." Be sure to consult with your tax advisor before making any decision.

Type of Industry

The type of industry your business is categorized as is an important consideration since there may be regulations pertaining to that industry in some states but not in others, or the regulations may be less stringent in some states.

Zlatkin offers this example, "Delaware does not charge state taxes for income from intangible assets. Therefore, a holding company for intellectual property might be set up in a state like that."

Corporation-Friendliness Factor

When comparing states, be sure to consider the state's reputation for being friendly to corporations. This is why many corporations select Delaware, says Ahmed. The state has "a robust body of corporate caselaw—Delaware even has its Court of Chancery which has been understood to be a more predictable judicial body allowing for potentially easier corporate planning," she explains.

If you are going to put forth the time and cost to incorporate in another state, you want to be sure it's going to be worth the effort in the long run, and choosing a state known for welcoming corporations can give you that peace of mind.

Disadvantages of Incorporating Elsewhere

While there may be advantages to be gained by forming your corporation in a state that is not your home state, there are also drawbacks. Zlatkin points out, "Most of the time, it'll end up costing more to incorporate in another state than the one that the business is located in."

Not only can it be more expensive from a formation perspective to set up shop in another state, but Weinstein also says that other disadvantages are "double taxation and additional compliance and paperwork. If you incorporate out of state, you're likely going to pay taxes in the state of incorporation and the state in which you live. You'll also likely have to report your business operations to both states and file documents with both states."

Closely Held Corporations

If your business is a closely held business, incorporating elsewhere may not offer you as many advantages as you might think. Many of the advantages to be gained have to do with publicly traded corporations.

For example, Delaware has special rules that protect the board of directors from shareholders and protect majority shareholders from minority shareholders. In a small, closely-held corporation, you may not encounter issues involving these concerns.

Additionally, if you are a small corporation, the costs of incorporating elsewhere can be more than your budget can handle, no matter what the inherent advantages are. Zlatkin points out, "Incorporating in a state other than your own is typically going to be a complication and, more often than not, will end up costing more, so there needs to be a quality reason for why the complication is worth it."

Deciding where to incorporate your business is a crucial decision that will have long-lasting implications in all areas of your business. Taking the time to research and investigate all the possibilities will help you make a smart decision.

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Brette Sember, J.D.

About the Author

Brette Sember, J.D.

Brette Sember, J.D. practiced law in New York, including divorce, mediation, family law, adoption, probate and estates, … Read more