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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
- 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.
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
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.
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.
Every state has filing fees and taxation structures for businesses, so there will be a cost wherever you incorporate. However, you can choose where to incorporate your business, so it doesn’t have to be where you do business.
Some businesses register out of state to take advantage of cheaper filing fees, fewer administration requirements, or better protection for their assets, while others will simply file wherever they do the most business.
The state that is the ‘best’ choice for one type of business might not work as effectively for another type of business, so careful consideration needs to be made to ensure that you are making the best decision when you are incorporating.
It is widely regarded that Delaware is the best state to incorporate in, and when you consider that more than 60% of the Fortune 500 companies are registered here, it is easy to see that this might be true.
In Delaware, cheap filing fees and taxes combine with better business protection to make a perfect place for incorporation. The Court of Chancery is an internationally recognized and respected business court with much experience in protecting businesses with enhanced privacy.
The worst state to incorporate in is probably New York, which has famously complex tax rules and several fees and charges that are not found in corporate ledgers elsewhere. Despite the recognizable zip code of a business incorporated in New York, the complicated filing system and unhelpful business support from the state make it among the worst places to incorporate.
For the cheapest incorporation rates, Mississippi is by far the least expensive – $50 for both Corporations and LLC filing.
It is worth considering that there is more to running a business from a certain state than cheap filing fees, however.
One of the biggest draws for incorporating in Delaware is the Court of the Chancery – an internationally known legal entity that is staffed by business-savvy judges and is known for protecting business (and their owners) through strong privacy laws.
For businesses that are looking for investment, Delaware is recognized as the home of more than half of all the Fortune 500 companies, so it is a popular choice for investors, too.
Another benefit of incorporating in Delaware is the low corporate tax rate, alongside a variable but favorable income tax rate and a sales tax rate of 0. In combination, this makes Delaware one of the cheapest places to incorporate, although it does favor a larger business.
Incorporating in Delaware is straightforward and simple.
Delaware corporate law is designed to protect the interest of businesses and their owners, through the Court of Chancery which is managed by legal and business experts.
With extended privacy laws and the work of the Court of Chancery, owners are personally shielded from business liability, and in most cases from creditors, too.
Incorporation in any state follows the same basic steps, with only a few differences in terms of the paperwork and fees that need to be paid.
One of the hardest parts of incorporating for most businesses is deciding whether to become an LLC, an S Corporation, or a C Corporation.
Once that has been decided, Articles of Incorporation or Organization need to be filed with the relevant secretary of state, with the relevant fees.
It is not hard to incorporate, but it can be a long and confusing process if you are doing it yourself – which is why there are businesses available that can do it for you.
There are two different definitions of foreign when it comes to incorporating, either as a business from a different state which is known as a foreign entity, or a business from another country.
Both can incorporate in the state of their choosing, and most choose to incorporate in Delaware or sometimes in Nevada, depending on things like business size and physical location.
Incorporation for both foreign businesses and so-called foreign entities has the same basic process as for a local business.
In most cases, the best state to incorporate a start-up is in the state where the business is based – however, for those that might be more tax-savvy there are some benefits to filing out of state.
This might mean Delaware, which is recognized as the best state for bigger businesses because of the wide range of protections offered as well as the tax implications. Smaller businesses might want to look at Nevada, which is another state known for supporting businesses through favorable taxation and an understanding legal system.
For many start-ups, filing fees are one of the most important considerations for where to incorporate – and this means that some start-ups might be looking for the cheapest options, which include Mississippi and Kentucky.
Most foreign startups will follow in the footsteps of the 60% or more of the Fortune 500 companies that are incorporated in Delaware – and a business does not have to actively work in Delaware to incorporate there.
All the business needs to do is appoint a Registered Agent in Delaware to receive all the relevant paperwork and legal documents that are needed.
Several states in the US don’t have income tax. These include:
- New Hampshire
- South Dakota
It is most common for a new business to incorporate in the state where it operates, however many businesses choose to incorporate outside of their ‘home’ state, in places that offer more favorable tax breaks, better business operational conditions, or offers better legal protection.
In most cases, the top choice for out-of-state incorporation is Delaware, and this is because of the Court of Chancery that offers a great level of legal protection for businesses, as well as fewer fees and cheaper tax options. Other options include Nevada and Mississippi.
Despite being one of the most popular choices for out-of-state businesses to incorporate in, Nevada actually has the highest fee for incorporation at $725. Alongside this, there are higher than average annual fees that need to be paid to keep the business running.
The benefit of an online business, in most cases, is that you don’t need a physical location to run it from – but you will still need to choose the most appropriate state to incorporate in.
With the out-of-state options in front of you, you might want to go for the protection and tax breaks of Delaware, the cheap filing costs of Mississippi, or the relaxed regulations of Nevada.
In some cases, the best way to choose is by size – Delaware and Nevada might be better choices if you are running a larger online business with a lot of turnover, while a smaller company might choose Mississippi or Wyoming.
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.