In the U.S., business entities are formed on a state level. This means that the taxpayer must choose a state to setup the business. Each state has unique rules for formation, corporate governance and tax. Therefore, not only is this a decision that must be made, but it can be an important decision. The options generally become clear when it is known where the business will physically be located, conduct business, and details about the operations and if there are any specific goals such as asset protection. There might be definitive options, or it might not make much of a difference with many viable possibilities.
Why It’s Not Important
Some states, such as Delaware, only tax income that is earned within the state. Many people choose Delaware due to favorable corporate governance laws; however, these laws rarely come into play. For the most part, the actual rules of each state are very similar. Some may offer better asset protection or better litigation options, but in actuality these are normally not a concern. The result is that there are many states you can pick that will likely have no impact on the business. While there is no strong reason to pick Delaware, there is also no strong reason not to, and with a quick process familiar to many attorneys it remains a favorable choice.
Why It’s Important
On the other hand, sometimes state laws can be a major issue. For example, in general California taxes California entities on worldwide income. A decision to incorporate in California could subject all corporate earnings to the high California corporate tax of 8.84%. If all income will be earned in California anyways this is not a concern. For a business with earnings outside California though, this is a major deterrent to form in the state. Also, you cannot avoid California tax through incorporating somewhere else. If the business will be conducted in California it will be taxed in California regardless of where it is formed. (see more here) Additionally, there are also logistical concerns. As of the writing of this blog, Nevada is experiencing a long backlog for processing, making an otherwise favorable state to form not a practical choice at the moment. This is a good reason to work with an experienced professional that specializes in these areas, picking the wrong state could cause you high taxes or unnecessary delays.
Overall, even though there are many things to consider, the choice of where to form a business is usually not a stressful or difficult decision when consulting with a professional. Choosing the wrong state can sometimes be a problem because liquidating or migrating is not always easy, or even possible. Therefore, it’s important to do it right from the start……or maybe it won’t matter.