Which state should I use for my new limited liability company?

People wonder, for example, if they should form a Delaware limited liability company. Delaware, as many people know, provides very sophisticated corporate laws. Large companies--all the big firms we hear about on the nightly news or read about in the local newspaper largely use Delaware as the state for the entities they create.

And people also often wonder about a forming a Nevada limited liability company because Nevada, so the rumor goes, allows a business and its owners to avoid paying taxes to their home state. Avoiding state income taxes (when legal) is obviously a profitable idea, right?

I don't want to bum you out, but most and maybe all of the time small business owners should simply form a limited liability company in their home state. In other words, choose a Delaware limited liability company when you'll operate in Delaware. And choose a Nevada limited liability company when you'll operate in Nevada.

Because this advice differs from what you'll sometimes get from well-meaning but unknowledgeable business friends, let me explain that there are two simple reasons for the basic advice to "stick with your home state."

Here's the first reason to form your limited liability company in the state where you'll operate. If you don't form a limited liability company in your home state, you will still need to register your out of state limited liability company as a "foreign" limited liability company in your home state. And this will mean that your LLC won't avoid state franchise taxes. For example, if you operate in California but don't want to pay the painful California LLC franchise tax, you certainly can form your LLC in next-door Nevada. No problem. But in order to legally operate in California, you'll need to register your Nevada limited liability company as a foreign LLC operating in California. This registration will trigger the California LLC franchise tax you may have hoped to avoid by forming an out of state LLC.

And here's the second reason to form your limited liability company in your home state. Almost surely, your home state will end up taxing your LLC's profits even though the LLC is formed in another state. For example, if you operate in New York but form a, say, Texas or Florida limited liability company, you're almost certainly going to end up paying New York state income taxes.

Your home state--New York, for example--will be able to tax your business profits if the entity operates in New York. And if your LLC is classified as a sole proprietorship, partnership or S corporation for tax accounting purposes, the business income will flow through to your individual federal and state income tax return anyway because the LLC passes through its income and deductions.

To sum things up, then, you probably want to form your LLC in your home state. Forming an out-of-state limited liability company typically doesn't let you avoid state LLC registration or franchise taxes. And forming an out-of-state limited liability company doesn't let you avoid state income taxes on the LLC's income. Yet, forming an out-of-state LLC does double your annual LLC paperwork.

Can I make one other related comment? If you want to avoid state taxes, the "clean" way to do this is by relocating your business and quite possibly your residence to another, low-tax state.

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