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Forming a New Business: How to Choose a State for Organization or Incorporation

If you have decided to start a new business, you will have a lot of important decisions to make. These decisions include what type of business entity you want to form (i.e. corporation, partnership, LLC, etc.), what types of products or services your business will offer to customers, how your business will be funded, whether you will hire employees initially, and more.

Many of those decisions will be spelled out in your initial business plan. Your business plan can help investors and strategic partners understand more about your business venture so they can make informed decisions about contributing capital. However, before you can finalize a business plan, there is another important decision to make: deciding which state will be the official, legal home for your new business.


Choosing Your Home State

The choice to organize a limited liability company or limited partnership, or to incorporate a for-profit or nonprofit corporation in a certain state may be as easy as choosing the state where you live (referred to as “home state incorporation” or “home state organization”). For many businesses, particularly small businesses with few investors, choosing to incorporate in the business owner's home state is a smart choice.

However, because there are a lot of operational and financial considerations that come into play when starting a new business, you should carefully evaluate your options before choosing a state to organize or incorporate in.

Important Considerations when Choosing a Formation State for a New Business

Most businesses have a lot of moving pieces, so decisions about where to form a business can hinge on operations-related factors or financial factors. Evaluating each of these can help new business owners make informed decisions.

Of course, you may decide to form your business in one state but have the business physically operate out of one or more additional states. While operational considerations like evaluating potential competition, analyzing the local labor market, calculating the impact of state-specific minimum wage and other labor and employment laws, and considering supply chain dependencies should impact your decision about where to establish a physical business presence, the decision to choose a state for organizing or incorporating your new business should hinge more on financial considerations.


Financial Factors that Business Owners Should Evaluate

Anyone thinking of starting a new business should also familiarize themselves with the potential financial implications of organizing or incorporating in one state over another. Some of those financial considerations are listed below.

  • Registration (startup) costs – Starting a new business in any state costs money, but the fees required to form a new business can vary widely from state to state. Do some research into states you may choose for your business location so you understand the up-front costs. Startup expenses are generally one-time fees.
  • Annual filings – Although the startup expenses are one-time fees, businesses in most states must also pay annual fees to renew and maintain their business registration.
  • Corporate income tax – Some states have a corporate income tax that business owners (or the corporate entity in the case of an incorporated business) are required to pay in addition to federal income taxes; other states have neither corporate nor personal income taxes. However, before you decide to organize your business in a state that does not have corporate or personal income taxes, understand that in order to take advantage of those benefits, your business would have to be physically located in that state.
  • Sales taxes – Consider whether your business could benefit from being incorporated or organized in a state with no sales tax on the goods or services you provide (or with a lower sales tax percentage than your home state).
  • Franchise taxes – Franchise taxes are taxes businesses pay just to be able to be organized or incorporated in a particular state. Not every state has franchise taxes, but many states do. These taxes are in addition to renewal costs, federal and state income taxes, and other tax requirements. These taxes and the methods of calculating them can vary widely, so it is important to do some homework in advance.
  • State-specific financial incentives – Different states offer various incentives to business owners to attract more new businesses. For example, some states offer tax breaks for environmentally friendly (“green”) businesses. New business organizers should evaluate various incentives to help them make an informed decision about where to organize or incorporate.
  • Registered agent fees – If you are considering forming a business in a state other than your home state, you will need to identify a registered agent in that state for service of process. There are professional organizations that can provide this type of service for an annual fee.
  • Court system – Although you never want to have to see the inside of a courtroom as a business owner, it is still important to understand how the court process works in the state where you are considering organizing or incorporating your business. There are some state-specific differences; some states are more business friendly when it comes to court processes than others, especially when it comes to the complex types of litigation big businesses can become embroiled in.

When it comes to evaluating the tax structures and laws of various states, it is important to remember that your business will be subject to the rules of the state(s) it is actually doing business in. Simply picking a state with favorable tax treatment will not do your business any good if you are located halfway across the country and have no ties to that state, other than on paper.

In fact, such an approach could end up costing you more money because you will have to pay registration and filing fees in the state(s) where you actually plan to conduct business too.

Considerations for Business Investors: Choice of State May Impact Investors' Decisions

Perhaps the most important consideration is whether the state you are looking at is business friendly. Whether you will be taking your business public or have a small circle of private investors, the state where you choose to organize or incorporate can have an impact on an investor’s decision to provide capital to your business or not.

If you have ever wondered why so many companies have chosen to incorporate their businesses in Delaware, it is because the state has a reputation for being “corporation friendly.” A long list of well-known publicly-traded corporations call Delaware home because of the state’s history of enacting laws that are favorable for businesses. Being able to predict how the court might rule on a certain issue gives both business owners and investors added confidence when making business and investment decisions.

Corporations in Delaware are also taxed at rates that are lower than many other states. In fact, Delaware corporations doing business in the state do not have to pay corporate taxes, nor does the state charge taxes on intangible assets like some other states do. This makes the state a popular choice with business owners and investors alike.

Domestic Entity as Opposed to Foreign Entity Registration

Another important point to understand is the distinction between "domestic" businesses and "foreign" businesses. When you choose to organize or incorporate in your home state, your business will be registered with the state as a domestic business. The word “domestic” in this context simply means that your business is physically located in that state.

If you select a state other than the state where you and your business will actually be located, you will have to incorporate or organize as a foreign business entity. The word “foreign” is sometimes concerning to business owners; however, it simply means that your business’s headquarters are in a different state than where your business is organized or incorporated.

What Is Involved in Organizing or Incorporating a Business Entity?

Whether they have a business presence in a particular state (domestic business) or not (foreign business), business owners wishing to organize or incorporate a new business entity must complete the following tasks:

  • Name a registered agent in the state – The registered agent is a company or individual who is physically located in the state where you are forming or incorporating your new business, and who agrees to accept service of process and legal notices on behalf of your business. This means that if your business is sued, or is named as a party in a lawsuit, the court documents and filings will be served on your registered agent. The registered agent is also typically the entity or person who receives official notices, including renewal notifications and reminders, from the state.
  • Ensure fees and filings are handled – Every state has its own fees and expenses for businesses wishing to incorporate or organize in that state. As part of the initial registration process, business owners and organizers must pay initial filing and registration fees. In addition, periodic and ongoing filings may be required in each state where a business is registered. In some states, those periodic filings come with their own filing fees. Business owners and organizers should also know that, depending on the state, fees and processes for foreign businesses can differ from those required for domestic business entities. When you are reviewing and evaluating fees and ongoing expenses, be sure to understand the nuances between domestic and foreign companies.
  • Understand and adhere to state tax obligations – As discussed above, some states provide tax incentives that may benefit certain businesses, while other states offer a different set of incentives and requirements. Business owners, and corporations for incorporated entities, must understand and stay on top of their business's tax obligations. It may be necessary to seek professional tax advice and representation to ensure your business is meeting its tax obligations, including what can sometimes seem like a complicated web of sales and use taxes, payroll taxes, franchise taxes, and income taxes.

Conclusion

As you can see, there are a lot of factors you should consider before choosing any one particular state in which to organize or incorporate your business entity. When forming a new business, you will want to carefully evaluate your options and the potential implications of those choices before deciding to organize or incorporate in a particular state.

As the factors that need to be analyzed will impact various types of businesses in different ways, there is not a one-size-fits-all solution, or a "best state" for every business.

Some business owners will find that organizing in their home state makes the most sense after conducting this analysis, while others will determine that forming a new business entity in a neighboring state, or even a state across the country, will prove to be the most advantageous based on their own circumstances and long-term goals for their business.

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