Choosing a State for Your Business Entity

Once you have chosen a type of legal business entity, it is time to choose a formation state. Also called the state of organization, domestic state, or home state, your formation state is where you will file your business’s formation documents, and its corporation or LLC statutes will govern your business entity.

When it comes to choosing a state for your business entity, it is important to keep all the following in mind:

• The cost of forming your business entity in the state in question 
• The state’s post-formation fees
• The compliance provisions included in the state’s governing statutes
• The state’s taxation laws

Each of these can vary considerably from state to state, making a clear understanding of your best options paramount.

It is up to you where you form your corporation, but there are some critical considerations to factor into your decision-making process. While there are states that are more business friendly than others, it is important to carefully weigh the pros and cons of venturing outside the state of your business’s location for formation. Consider the following:

• Every state other than the one in which you form your business entity is considered foreign.
• If you form your business in a state other than the one in which you conduct business, you will need to qualify – or register – in the state your businesses is actually located. 
• Registering in a foreign state not only adds expense, such as the cost of qualification and annual fees but also applies a new layer of compliance obligations and tax implications.  

The cost of compliance with the corporate laws and taxation requirements of the state in which you do business (the state of foreign qualification) and the state in which you form (the state of formation) can outpace the benefits of forming your business outside the state of its location.

When you are making a decision about which state is the best option for forming your business entity, there are several financial factors that should be carefully considered. 

Start-up Costs 

While every state requires startup – or registration – costs, the amount can vary considerably from state to state. Registration fees are typically a one-time expense but knowing the up-front costs of forming a business in a specific state is a good place to start. 

Annual Filing Fees

Most states impose annual filing fees that are required in order to maintain and renew your business’s registration from year to year. Because these annual fees are ongoing, they require more careful attention in relation to your business-formation decisions. 

Corporate Income Tax

The corporate income tax in the state in which you form your business entity is a primary consideration. Some states implement a corporate income tax that is in addition to the business’s federal income tax (as governed by the IRS). While some states levy neither personal nor corporate income tax, your business will need to be physically located in one of them in order to benefit from the savings.

Registered Agent Fees

If you do not incorporate in your home state, you will need to identify a registered agent for process purposes, and this generally involves paying an annual fee to hire an agent in the formation state. 

Franchise Tax 

If your business is a franchise, it is important to understand that many states require franchise taxes – in addition to other federal and state fees, taxes, and expenses – in order for you to incorporate within. Franchise taxes vary significantly, which makes doing your homework imperative. 

Financial Incentives in the State of Formation

Some states are highly invested in attracting business entities, including the State of Delaware, and as a result they offer financial incentives in addition to other forms of corporate support. Balancing the pros of forming in a foreign state with the financial advantage of forming in your home state is an important piece in the business puzzle. 

The Court and Your Business

Your goal is naturally to keep your business out of court, and this generally is fine for small business owners. In the world of big business, however, complex litigation is common, and having a solid understanding of how pro-business the courts are in the state you are considering incorporating is well-advised.

An important aspect of growing a business is attracting investors, and where you form your business can play an essential role in this process. How business friendly the state in which you form is can be the deciding factor in whether or not you are able to obtain the investment capital necessary to reach your business’s full potential. Some states welcome corporations with open arms while others take a more neutral stance, and there is also the matter of determining if the financial advantages of staying put outweigh the benefits of forming outside your home state – regardless of how inviting. 

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