Which State Should I Use For an S Corporation?

Choosing a state for a new corporation or limited liability company (you'll use one of these entities as the "platform" for an S corporation) can be confusing.

Not surprisingly, then, entrepreneurs and small business owners regularly ask if they should consider setting up a Delaware corporation or limited liability company or about incorporating in Nevada.

Big publicly-held corporations, for example, almost exclusively use Delaware as the state for the entities they create. Many of us know what.

And incorporating in Nevada, so the rumor goes, allows a business and its shareholders to avoid paying state income taxes and franchise taxes. which sounds like a great idea every tax season...

Probably You Want Your Home State

Despite this sort of talk, however, most small business owners should simply incorporate (either form a corporation or limited liability company) in their state of residence and operation.

In other words, choose a Delaware limited liability company or corporation only when you live and you'll operate in Delaware. And choose a Nevada limited liability company or corporation only when you live and you'll operate in Nevada.

Because this advice differs from what you may hear from well-meaning but ignorant friends, let me explain that there are two simple reasons for choosing your home state.

Out-of-state Corporations Trigger Foreign Registration

If you don't incorporate in your home state (the one where you'll operate your business), you will still need to register your out-of-state corporation or LLC as a "foreign" corporation or limited liability company operating in your home state. Registration will mean that your corporation or LLC will pay home state fees and franchise taxes.

For example, if you operate in California but don't want to pay the painful California LLC franchise tax, you certainly can incorporate in next-door Nevada. No problem. But in order to legally operate in California, you'll need to register your Nevada company as a foreign corporation or limited liability company operating in California. This registration will trigger the California fees and franchise taxes.

Out-of-state Corporations Won't Save Taxes

And here's something else you need to know...Almost surely, your home state will end up taxing your corporation's or LLC's profits even if the company is set up in some other state. For example, if you operate in New York but form a, say, Texas or Florida corporation or limited liability company, New York state (as well as the local municipal taxing authority) still gets to tax your business profits. That's the way federal and state tax laws work.

To summarize, then, incorporate in your home state. Incorporating out-of-state doesn't let you avoid state corporate franchise taxes. And incorporating out-of-state doesn't let you avoid incorporation fees or state income taxes.

One final, slightly impolitic comment: To legally avoid or minimize state taxes, you do have an easy option--you can simply relocate your business and residence to another, low-tax state.

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