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When working with new entrepreneurs, I often get asked about the best state to form their new business. For most small businesses the answer is to form your entity in your home state (i.e., the state in which you conduct your business and the location of most of the business’s property, shareholders/members, and employees). 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 also disadvantages. 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 that hears disputes involving the internal affairs of business entities. This special court is well-known for its speed, judges who have been trained in business matters, and the fact that there are no juries. Further, Delaware has the most fully developed 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 attributes is that business owners have more flexibility in how to manage their businesses and because the results of a dispute litigated in the Chancery Court are more predictable, management has more certainty regarding how to operate the business. Nevada Advantages Nevada is a fairly new player in the entity formation game, but it’s growing fast. The main advantage of forming your entity in Nevada is that Nevada has low filing fees, no business income tax, franchise tax, capital gains tax, state corporation 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 return information are confidential. However, there is an exception for dealing with States provided there is an “agreement of cooperation” with the IRS to exchange information on taxpayers. [Code § 6103(d)]. 48 states have an agreement with the IRS. Currently, Nevada and Texas do not. Very little disclosure is required. Many business owners who are interested in privacy or asset protection will choose Nevada for this reason. Wyoming Advantages Wyoming, like Nevada, has no business or franchise taxes. In addition, like Nevada, Wyoming requires very little disclosure when forming an entity. However, Wyoming has the added advantage of allowing a lifetime proxy. This allows the true owner to hide his/her/its identity while still controlling the vote. These privacy advantages are sometimes important to certain owners to implement certain asset protection strategies. Disadvantages of Not Forming your Entity in your Home State Most of the advantages discussed above provide only minor benefits for small business owners. Many times the hassle and 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 that transact business within its borders to register as a “foreign” entity with that state. Thus, even though your entity was formed 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, you may 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 where a majority of its property, owners, and employees reside. However, there are many factors that may apply in a particular company’s situation that could impact the decision about where to form an entity. Thus, if your company has more than five owners or has particular concerns such as taxes or asset protection, the business owners should seek competent counsel prior to forming an entity in a particular state. For more articles about Finance, Business and Law, please visit www.biztaxbuzz.com
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