How to Select the Best State for Incorporation

By Business Filings Incorporated

One of the first decisions business owners must make after deciding to incorporate or form a limited liability company (LLC) involves selecting the state of formation. They are not required to incorporate in the state where their business operates and can choose from any of the 50 states or the District of Columbia.

In making the decision of where to incorporate, three factors typically are weighed: the location of the physical facilities (the home state), the cost of incorporating in the home state versus incorporating in another state and possibly having to register to transact business in the home state, and the advantages and disadvantages of each state’s corporate or LLC laws. 

Forming in the Home State Versus Another State
For many small business owners, the decision of where to form their corporation or LLC often comes down to their home state or Delaware. Again, the home state is the state in which the business is physically located. Business owners often think that Delaware is the place to be formed. Over half of the Fortune 500 companies are incorporated in Delaware, but Delaware’s advantages may not be as beneficial for very small businesses.

Delaware is chosen as the state of incorporation for a number of reasons: for having a separate court system for corporate law (called the Court of Chancery) that has only judges and no juries; for not imposing income tax on corporations and LLCs formed in Delaware but not transacting business there; and for having one of the lowest formation costs. Additionally, Delaware has favorable corporate laws that give corporations and LLCs wide latitude in establishing their internal governance.

For closely held corporations, which are those with only a few shareholders, and for small LLCs, these advantages may not be as useful. Small businesses typically have a smaller number of owners, and lawsuits (either shareholder suits or external lawsuits) are not as common. Also, the low cost of incorporating in Delaware may be negated if the company is transacting business in the home state and/or other states, and therefore must also qualify to do business in those states.

Registering to Transact Business in Other States
Corporations and LLCs that are transacting business outside of their state of formation may be required to “foreign qualify” to transact business in these other states. Corporations and LLCs are viewed as “foreign” in all states except the state of formation. Having businesses foreign qualify is a way for the states to know that foreign corporations and LLCs are operating within the state. It also provides the corporation or LLC with access to that state’s courts.

The definition of what constitutes transacting business varies by state. Factors often considered are whether the corporation or LLC has a physical facility, a bank account, and/or employees in the state. To determine if your business will need to foreign qualify, it is best to seek the advice of an attorney.

In order to foreign qualify, the business must file the appropriate paperwork, typically called a certificate of authority, with the state in which it wishes to qualify, and pay the necessary filing fees. Corporations and LLCs that are qualified in other states are also required comply with that state’s annual reporting and taxation requirements.

For many small business owners evaluating whether to form in another state because it seems cheaper, this may not prove to be the case if foreign qualification is necessary. They could be faced with two sets of fees at formation, the formation fees and the qualification fees. They would also face annual reporting and taxation requirements for both the state of formation and state of qualification, which can result in additional, ongoing costs.

Being Familiar with the State Statutes
Another factor to consider when evaluating where to form a business is the advantages and disadvantages of the corporate or LLC statutes in the states being considering. Business owners can typically find information on a state’s requirements and statutes for corporations and LLCs on the Secretary of State’s web site.

Deciding where to form a business is not always an easy decision to make. There may be other factors besides the three mentioned above that pertain to a particular business situation. For advice on where to incorporate your business or form your LLC, it is best to consult an attorney.