One of the most frequently asked questions by prospective business incorporation filers is, “which state should I incorporate in?”
It’s a good question and the answer isn’t always clear cut. For example, you’ve no doubt heard about the perceived tax and operational advantages of incorporating in states such as Nevada (with its low filing fees and zero state corporate income, franchise and personal income taxes) and Delaware (with its flexible and pro-business statutes). But do these advantages really come into play for small business owners? Do you really want to tie your small business up legally with a state other than your own? What if your business operates largely online with customers in many states?
Here’s what you need to know about choosing a state in which to incorporate.
Why Incorporating in Your Home State May Be the Best Option
If you operate a small business and anticipate having less than five shareholders or members of your incorporated business, then it’s widely considered the best strategy to incorporate in the state where you have a physical presence (property, shareholders, employees) – and for most small businesses, this is in their home state.
Why? Even with the benefits of incorporating in states such as Nevada and Delaware, the hassles often outweigh the benefits.
Consider the following:
- Even if you incorporate in tax-friendly Nevada, if you are operating or doing business in your home state, you’ll still have to pay business taxes on revenue that originates in that home state.
- If you don’t have a physical address in the state in which you incorporate, you’ll need to hire and pay a registered agent in that state to act as your legal representative.
- If you are incorporated outside your home state, you’ll need to file for a foreign qualification in both your home state (if you wish to do business there) and in the state in which you are incorporated. This means double-duty paperwork, filing fees, taxes, and even penalties if you inadvertently skip this important step. You may even have an increased tax liability in your home state because you are registered as a foreign entity there. You are also subject to the same annual reporting requirements in both states.
- If you register out of state, you’ll be subject to the laws of that foreign state of corporation. These laws may differ from those of your own state (and state laws can vary significantly in many areas). This can have complicated ramifications and may require your presence in court in your registered state, if you run into even the simplest of legal disputes.
- As a “foreign” business, you may also encounter difficulties opening a business bank account in either or both the states in which you are incorporated in and physically located.
Unless you intend to transact business in states like Nevada or Delaware, filing in these states has very few long-term advantages. Yes, the tax laws and ease of doing business may be appealing at first, but peel back the onion and you’ll find that, in the long run, it is more economical and time-saving for small businesses to pursue home-state incorporation.
Where Should You Incorporate an Online Business?
Choosing a state in which to incorporate your online business involves pretty much the same steps as a brick and mortar business. For example, if you intend to market and sell to a relatively local market, then filing in your home state will make the most sense.
However, it’s important to get legal advice and weigh the pros and cons. Many small online businesses choose to incorporate in their home state because that’s where they have a physical presence (such as a home-based business) and it’s also often where most of their employees are situated, regardless of where their customer base is.
If your online business grows and you open a physical location in another state, you’ll need to apply for a foreign qualification in each state in which you are doing business (including your original home state). Foreign qualification is technically a form of incorporation, and your company will be responsible for the associated fees and laws in that state. As a rule of thumb, if your business meets any of the following criteria in a state other than your home state, then you should check with the state government and/or a lawyer to find out about applying for a foreign qualification:
- Your business has a physical presence in the state
- Your business has employees in the state
- Your business accepts orders in the state
- Your business has a bank account in the state
Disclaimer: The information in this blog doesn’t constitute legal advice. Always consult a lawyer to find the incorporation option that best suits your needs.
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