The Best State to Incorporate a Business
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The process of forming a company or corporate entity that is separate from your own personal identity is known as incorporation. This leads to a number of business structures, including:
- Limited liability company (LLC)
- Limited liability partnership (LLP)
- Limited partnership (LP)
There are several benefits to incorporation, including:
- Limitation of liability to company assets and hence protection of personal assets
- Simplification of the company transfer process to a new owner
- The option to receive capital in return for company shares
- A range of tax advantages
It is this final benefit of the treatment of tax that will generally influence your decision about in which US state you decide to incorporate your business. The taxation process for businesses and individuals differs across US states. Some are deemed to be more business-friendly and advantageous than others.
Your choice of US state to incorporate a business will depend on how well the tax climate and other pertinent factors of that state match your business needs.
How Do You Choose Which State to Incorporate In?
There are seven main factors to consider when deciding in which US state to incorporate your business. Most of these are related to cost and the treatment of tax.
How Much Are the Formation Fees?
The process of incorporation incurs a one-time filing fee, payable to the relevant secretary of state office. The amount of the formation fee varies between US states. For instance, in 2021 it is $50 in Iowa, but $250 in Alaska.
While you may wish to limit the amount of financial outlay at the incorporation stage, it is always wise to balance this factor with what else the state has to offer.
How Much Is the Annual Fee?
This is an ongoing fee paid to the state every one or two years. As with the formation fee, annual fees vary between US states. This fee is required to maintain your company and must generally be accompanied by a report on aspects of the business’s performance.
2021 annual fees range from $75 in Illinois to $300 in Delaware. Several US states, including Arizona, Missouri, New Mexico, Ohio and South Carolina, do not charge an annual fee.
Does Corporate Income Tax Apply?
This tax on the income of the company is not charged in all US states. In 2021, 44 states charge corporate income tax ranging from 2.5% to 11.5%.
Certain states charge an increasing percentage of tax as income climbs. For instance, Arkansas charges 2% tax on corporate income between $3,000 and $6,000, but 6.2% on corporate income over $100,000. Other states charge a blanket percentage regardless of company income.
Six states do not charge corporate income. These are:
- South Dakota
However, Nevada, Ohio, Texas and Washington charge gross receipts tax instead of corporate income tax. South Dakota and Wyoming charge neither kind of tax.
Do Franchise Taxes Apply?
The way that franchise tax is calculated varies from state to state. In certain states, it is based on company income. In others, it is calculated from the value and number of shares.
It is always recommended that you check with any state you are considering for incorporation whether they charge franchise tax and on what basis.
How Is the State Legal System Set Up?
Does the state handle business law cases separately from other types of law cases? Specifically, are business law cases in the state handled by a judge rather than a jury?
States that separate their handling of business litigation and use a judge to make a ruling instead of a jury generally see a quicker turnaround of cases.
Which State Do Your Investors Prefer?
Do your investors have a preference for incorporation in a specific state? Will the choice of state affect whether or not they invest further or invest at all?
They may even have experience of incorporation in a particular state that will prove helpful.
What Are Your Future Plans?
You may be attracted to incorporating in a state because it suits your business now. For instance, the formation fees may be low and the individual income tax may be minimal.
But how will the state’s treatment of tax, such as higher rate corporation tax or restriction of share numbers, affect your business’s growth? Are there signs that tax rates are likely to rise in that state? How wealthy is the state? Is it attracting investment overall?
Consider not only whether a state is a good fit now, but whether it will benefit your business going forward.
Should You Incorporate in Another State?
Now that you know all the factors to consider when choosing which state to incorporate in, your next decision should be whether to choose your home state or another US state.
Reasons to Choose Your Home State
- Familiarity – Having formed and run a business in your home state, you will already be familiar with the local tax treatment and business laws. Incorporating your business in the state where it is already registered will be a simpler process than choosing another state.
- Keeping the same business name – You have already registered your business name in your home state so you can take that name forward when you incorporate there. However, if you choose to incorporate in another state, that name may not be available to you.
- Tax and fee treatment – Your home state may already offer the best tax and fee conditions for your business.
- No need to register as a foreign entity – If you decide to incorporate in your home state and only do business there, you will avoid the added complication and expense of registering as a foreign entity.
- Local law proceedings – If you incorporate in your home state, any legal proceedings will take place there. Should you incorporate in another state, it may be unclear where any future law cases will be handled.
- Less than five shareholders – If your incorporated business will have less than five shareholders, it will generally be to your advantage to incorporate in your home state.
Reasons to Choose Another State
The main reasons to incorporate in another state instead of your home state are:
- An improved tax situation
- To take advantage of a more business-friendly environment
Top 5 Best States in Which to Incorporate
The thought of choosing which state out of 50 to incorporate your business may be a little overwhelming at this stage. As a starting point, you may like to consider our top five best states to incorporate your business.
The tax rate and conditions mentioned in the following sections are based on 2021 figures. This list is not ordered.
Corporate tax rate: Depends on company income – 0% up to $25,000; 2% up to $49,000; ranging up to 9.4% for an income over $222,000
Individual income tax rate: 0
Sales tax rate: The state sales tax rate is 0 but there may be a local sales tax rate of around 1.76%
The zero individual income tax rate and low sales tax rate make Alaska an attractive prospect for businesses that wish to incorporate. Despite its remote location, Alaska appears in our Top 5 because of its tax environment and the tax credits made available to newly registered businesses depending on certain qualifying factors such as industry.
Tax credits include new area development and exploration incentive. There is also a range of loan programs including small business economic development and microloans for women entrepreneurs.
Corporate tax rate: 8.7% for businesses that make an income above 0
Individual income tax rate: Varies depending on income and whether you file as a single person, married person (jointly or separately) or head of household. Ranging from 0% to 6.6%.
Sales tax rate: 0
Delaware is often considered the best state to incorporate for large businesses because of the multiple tax benefits, such as the zero sales tax and zero tax on fixed-income investments by corporations.
Delaware offers a high level of corporate and board structure flexibility. Business law cases are attended by a judge with established corporate legal expertise.
Incorporation costs are low, and the process is generally straightforward. Delaware is widely popular with investors.
Corporate tax rate: 4.458%
Individual income tax rate: 0
Sales tax rate: State 6%; average local 1.08%
Florida is a popular state for incorporation with businesses of all sizes. The wide range of tax benefits include:
- Zero individual income tax rate
- Relatively low corporate tax rate
- Exemption of capital stock from corporate franchise tax.
There is also a number of business growth incentive schemes for start-ups, including the Capital Investment Tax Credit and Quick Response Training.
Corporate tax rate: No corporate tax but there is a gross receipts tax
Individual income tax rate: 0
Sales tax rate: State 6.85%; average local 1.38%
The most obvious benefit to choosing Nevada to incorporate a business is the freedom from many state taxes, such as individual income tax, corporation tax and franchise tax. However, a gross receipts tax is applicable to business income.
Nevada is the only state that has no formal information-sharing agreement with the IRS. This provides enhanced privacy for businesses, especially regarding the identity of directors and investors. Incorporation in Nevada also limits any liability to the business itself.
There is no requirement that directors, shareholders or corporation members be residents of Nevada.
Corporate tax rate: 0
Individual income tax rate: 0
Sales tax rate: State 4%; average local 1.33%
The biggest attraction to incorporating in Wyoming is the tax advantages provided, such as the zero corporate and individual income tax liability.
There is also zero:
- Excise tax
- Inheritance tax
- Tax on intangible assets, for instance, stock or bonds
Manufacturing businesses may also benefit from tax exemptions on sales and electricity.
Wyoming generally makes fewer demands on your business, for instance, there is no restriction on the number of unlimited shares you can issue and there is no minimum amount of capital required at the point of incorporation.
Registering as a Foreign Entity
Whichever US state you decide to incorporate your business in, you will generally be required to register as a foreign entity if:
- You wish to carry out business in any state other than the state of incorporation, including opening a new work base
- Your employees are residents of another state
- You bid on a contract in another state
- You obtain a professional license in another state
- You intend to open a bank account for your business in another state
Should you fail to register your business as a foreign entity before carrying out any of the above, you may face a significant fine and legal action.
You may register your business as a foreign entity at the point of incorporation or at a later date before carrying out business in another state. You must go through this registration process for each state where you wish to do business.
The exact requirements and process may vary between states. You will generally be asked to provide:
- Company details, such as business name, formation date, address and number of shares
- A copy of your formation documents
- Name and address of your agent in the state where you are seeking registration
- In certain states, a certificate of good standing from the state in which your business was incorporated
The cost of registering your business as a foreign entity will vary from state to state, ranging from $75 up to $300–$400.
Selecting which state to incorporate in is a strategic decision. It requires a level of investigation to identify a state whose strengths and weaknesses align with those of your business.
Weigh up the advantages of each state in the areas of tax treatment, incorporation fees, levels of privacy and legal system to find the best fit for your business, both now and in the future.