Where Should I Form My Business? (A Brief Overview) |BizTaxBuzz by Trevor Crow

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12thJulyWhere Should I Form My Business? (A Brief Overview)

Posted by Trevor Crow

When working with new entrepreneurs, I often get asked about the best state toform their new business. For most small businesses the answer is to form your entity in your home state (i.e., the state inwhich you conduct your business and the location of most of the business’s property, shareholders/members, andemployees).

If you are researching this issue, you will find a lot information about forming entities in certain states, such as Delaware,Nevada and even Wyoming. There are definitely advantages to forming your entity in these states, but there are alsodisadvantages. I briefly outlined these advantages and disadvantages below:

Delaware Advantages

The main advantage of forming an entity in Delaware is its Chancery Court. The Chancery Court is a special court thathears disputes involving the internal affairs of business entities. This special court is well- known for its speed, judgeswho have been trained in business matters, and the fact that there are no juries. Further, Delaware has the most fullydeveloped body of case law, created over hundreds of years. Finally, Delaware is known for its flexible and pro-management entity statutes, which entices business owners to incorporate there. The combined effect of these attributesis that business owners have more flexibility in how to manage their businesses and because the results of a disputelitigated in the Chancery Court are more predictable, management has more certainty regarding how to operate thebusiness.

Nevada Advantages

Nevada is a fairly new player in the entity formation game, but it’s growing fast. The main advantage of forming yourentity in Nevada is that Nevada has low filing fees, no business income tax, franchise tax, capital gains tax, statecorporation tax or inheritance tax. Other advantages of forming your business in Nevada include:

Nevada has no Agreement of Cooperation with the IRS. Under the U.S. tax code, a taxpayer’s return and returninformation are confidential. However, there is an exception for dealing with States provided there is an “agreement ofcooperation” with the IRS to exchange information on taxpayers. [Code § 6103(d)]. 48 states have an agreement with theIRS. Currently, Nevada and Texas do not.

Very little disclosure is required. Many business owners who are interested in privacy or asset protection will chooseNevada for this reason.

Wyoming Advantages

Wyoming, like Nevada, has no business or franchise taxes. In addition, like Nevada, Wyoming requires very littledisclosure when forming an entity. However, Wyoming has the added advantage of allowing a lifetime proxy. This allowsthe true owner to hide his/her/its identity while still controlling the vote. These privacy advantages are sometimesimportant to certain owners to implement certain asset protection strategies.

Disadvantages of Not Forming your Ent ity in your Home State

Most of the advantages discussed above provide only minor benefits for small business owners. Many times the hassleand cost of maintaining an entity outside your home state outweighs the benefits.

The main disadvantage of not forming your entity in your home state is that most, if not all, states require entities thattransact business within its borders to register as a “foreign” entity with that state. Thus, even though your entity wasformed in Delaware, you would still have to file reports and pay taxes in the state in which you operate your business.

Other Disadvantages to consider:

Forming your entity outside your home state opens the door for someone to sue you in your formation state. Thus, youmay be forced to hire out of state counsel and to appear in court outside your home state.

You must have a registered agent in the state where you form your entity.

You may even have an increased tax liability in your home state because you are registered as a foreign entity there.

Bottom Line. A general rule to follow is that businesses with five or less owners should form the entity in the state wherea majority of its property, owners, and employees reside. However, there are many factors that may apply in a particularcompany’s situation that could impact the decision about where to form an entity. Thus, if your company has more thanfive owners or has particular concerns such as taxes or asset protection, the business owners should seek competentcounsel prior to forming an entity in a particular state.