One of the biggest decisions a small business owner must make is “where should I incorporate?” The most logical and common answer is the state in which the business resides. Generally speaking this is probably the best choice.
A business owner is not legally obligated to incorporate in their home state, though. Often times there are advantages to incorporating elsewhere such as tax and cost related benefits. There are “corporation-friendly” states that offer incentives for incorporating your business there.
Although there may be incentives to leave your home state, the biggest question you should ask yourself is: “should you?”
There are three main factors to consider when deciding whether or not to incorporate in a different state: tax considerations, cost considerations and jurisdictional considerations. Many times, after thorough analysis of these factors, business owners find that the best option is incorporation in the state that the business is located.
That being said, let’s take a look at each factor individually.
From state to state, the characteristics of a corporation remain relatively the same. The applicable state tax rates, however, vary widely. Some states have tax rates as high as 10% whereas other states, such as Nevada, have no franchise tax or state income tax. The tax breaks are part of what makes Nevada such a desirable state in which to incorporate. However, incorporation in Nevada does not excuse you from paying taxes in your home state because every state requires taxes be paid by businesses operating within its borders.
Although incorporating your business does not require you to retain a lawyer, seeking some legal counsel is advisable due to the complexity of the process. If you decide to incorporate outside of your home state, it is best to seek the counsel of a licensed and practicing lawyer in that state.
Each state requires that a corporation has a resident agent for service of process located at a physical address within that state. There are firms that provide this service at a nominal fee ranging between $125 and $200 per year. A corporation without a physical address in the state will be required to pay an authorized company for this service.
Additionally, there is the paperwork required to apply for qualification to do business in that state. Every state requires this type of registration. This process can involve paying filing fees, supplying reporting requirements and even possibly paying penalties if you have conducted business prior to registering. Typically, a corporation will end up having to pay maintenance fees and taxes in its home state as well as in the state of incorporation during this process.
When a corporation is incorporated in one state and headquartered in another, it is subject to the jurisdiction and service processes of the state of incorporation. This can prove to be problematic or inconvenient for a number of different reasons.
One of those reasons is that any communications, such as legal notices, in the state of incorporation must go through your registered agent in that state. This means that important documents or time-sensitive information may be misplaced or may not reach you in time.
Another downside is that your corporation is governed by the laws of that foreign state. This is problematic because in many states, the court system requires that you appear in that state’s court if and when any legal disputes arise.
Why Should You Incorporate in Your Home State
If the business you operate is a small business and you anticipate having five or fewer shareholder, then it is usually considered best practice to incorporate in the state where you have the most physical presence. The physical presence includes employees, property and shareholders and for most small businesses, is their home state.
Many small businesses will attempt to protect their assets and avoid paying taxes by incorporating in a “tax-free” state like Delaware or Nevada. However, there are drawbacks to falling for an out-of-state incorporation plan:
Typically, you will still have to pay taxes in your home state: Even if you incorporate in a state like Nevada where there is no corporate or state tax and you do business within another state that does, you will be responsible for paying taxes on your profits anyway. This is often overlooked by over zealous small business owners in search of an easy way around paying taxes.
You raise your administrative costs: As previously mentioned, by incorporating in a foreign state you will incur the added costs of a registered agent in that state as well as additional out-of-state filing fees. In addition, you may have to file a “foreign registration” document in your home state.
You put your personal assets in danger: Your business must be registered in the state where you are doing business in order for your personal assets to be protected from business-related liabilities. If you are registered out of state, your personal assets are exposed.
You may run into banking troubles: As a “foreign business,” you can run into problems opening up a bank account in both your incorporation state and in the state you are physically located.
Transparency is the new privacy: There was a time when incorporating in Nevada or Delaware came with strict privacy rules that protected certain information such as the identity of officers and directors. However, recently these states have tightened their disclosure rules. Because a new corporation will have to register as a foreign entity, it will have to disclose all management individuals.
As you can see, there are both advantages and drawbacks to incorporating in other states. However, for small businesses it is generally accepted as best practice to incorporate in your home state.
Incorporating in your home state can save you not only mounds of paperwork but also mounds money. Each situation should be handled on a case-by-case basis and, in general, legal counsel should be sought.
Armed with knowledge of laws and regulations, you should be ready for your business’ incorporation.