Choosing a state for your new limited liability company can sometimes be a little confusing.
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.
In most cases, the most practical state you can choose for your new limited liability company is the state in which you operate your business or the state in which your investment is located. In other words, if you’re setting up an LLC to own investment property in Florida, you want to setup a Florida limited liability company. And if you’re setting up an LLC for a construction business you operate in Ohio, you want to setup an Ohio limited liability company.
Some entrepreneurs and investors do pick other states and some of the time, going with another state’s LLC can be a good decision. Attorneys, for example, often like Delaware limited liability companies. Many attorneys say that the Delaware courts are the most sophisticated and business friendly in the country. And, what’s more, Delaware provides entrepreneurs and investors with something called a multiple series llc, which lets you compartmentalize investments and business activities within a particular LLC into subsidiary LLCs.
Note: The sophisticated and business friendly legal environment of Delaware explains why all the really large corporations in America are Delaware corporations.
Another popular state is a Nevada because Nevada doesn’t levy a state corporate income tax. In some very limited circumstances, a business owner or investor might save state income taxes by choosing Nevada llc formation or incorporation. However this idea is, in my opinion, way, way oversold–usually by sloppy incorporation services selling their wares to ignorant taxpayers who don’t realize they’re on their way to income tax evasion.
A related comment about choosing the right state for your limited liability company: In addition to setting up your LLC in some state, you’ll also need to register your LLC as a foreign limited liability company in any other state where your LLC owns property, invests or operates a business. For example, if your Nevada LLC operates a business in California, you’ll need to register your Nevada LLC as a foreign LLC operating in California. (Obviously, when you do register a foreign LLC in some other state, that alerts that other state to your presence and they will probably begin to tax you and your LLC.)