The advantages and disadvantages of incorporating in another state are hotly debated. We’ve seen a lot of other business-filing companies and services extol the virtues of incorporating in Nevada or Delaware, but the reality of the situation is a bit more nuanced. More often than not these other companies are trying to convince you of the need of their services and, while we could do the same, we want to actually help people, not just sell them something. For most businesses, incorporating outside of their home state isn’t a good idea. You have to contend with foreign qualification fees, regulations, licensing, and, to top it all off, the main state you do business in will probably still want to collect the same amount of taxes as they would if the business was formed in its borders. So the question inevitably shifts from ‘should you go to another state?’ to ‘in what cases would forming in another state be advantageous?’. Well, you’d typically want to form outside of your home state for the following reasons.
Yes, we know we just disparaged the tax argument, and most small businesses will just have to accept there is no escaping the tax-man. However, in a few, select cases, you can save money on your tax bill by forming your business in a state other than the one you do business in. Some states have a high ‘nexus’ point – the point where they begin charging foreign corporations for doing business in their borders. Michigan, for example, will only collect corporate tax if the foreign corporation is bringing in more than $350,000 from Michigan sales. Others have a lower nexus point – California will collect corporate tax if you derive 25% of your sales from the state, regardless of the amount you sell. The important thing to remember is that states with a high corporate tax are very adept at dealing with business trying to escape those rates.
If you have venture capital investors, they may also ask that you incorporate in another state for tax reasons. Many VC firms prefer corporations in Delaware because Delaware does not charge any tax on shares held by non-residents. Since VC firms are going to hold shares of your company, they’d rather you incorporate in a tax-friendly state. But, again, few business are going to secure venture capital, and incorporating in a state like Delaware ‘just-in-case’ is putting the cart before the horse.
Certain states are very highly regarded for their support of small business – a recent poll by the Washington Post found that Nevada, Minnesota, and Georgia topped the list of best states to do business in. And that kind of support can be very attractive to a new business. Incorporation and formation fees are low, the legal barrier protecting business owners and directors is stronger, and there are just more programs that a new business can take advantage of. If you’ve ever felt left out in the cold by your home-state, then forming elsewhere and qualifying as a foreign entity in your original state might be worth the effort and cost.
Namely, operating within multiple states. If you run a business that has a presence across state lines, then it can make sense to find a friendlier state to form your company in. When it comes to multi-state businesses, most states will only collect tax on income derived from within the state. So why increase your tax burden by setting your headquarters in a state that heavily taxes corporate profit? Certain states also have low costs of hiring, or a built in infrastructure that you can take advantage of to boost your operations. If you need to be close to a harbor, for example, you don’t want to form a corporation in Nevada, no matter how business-friendly the state is. So make sure to take your infrastructural and operational needs into consideration when choosing a state of formation.
Most small businesses will not be in a position to benefit from incorporating in a state other than the one they do business in. The overall cost from fees, taxes, and regulations is just too high. However, in some select cases, there are advantages to incorporating outside of your home state. Before you do, though, make sure you sit down with your lawyer, accountant, or another professional to make sure that choosing another formation state is a good decision.