This is the eternal and perpetual question just about every client starting a company wants answered, and perhaps some insight may be provided here. Nothing here may be deemed indisputable fact, merely the opinions of a legal professional, and other experts may differ, as in any other field. Generally most legal service providers will want to form as many entities as possibly so as to increase fees without regard for what is in the best interests of the client. The general guise of this course of action is generally “asset protection”. The answer is that unless a specific reason exists to form a legal entity out of state, the company should be formed in your home state, no matter how oppressive or expensive the laws of your state make owning such a company.
The reason for this is that if you have business operations in your home state you will likely need to register any foreign company in your home state as well, paying the additional fee, and still be liable for all taxes and costs of owning such a company, including personal taxes. The asset protection benefits are generally not worth the trouble, except in specific circumstances, which you should discuss with competent asset protection legal counsel. Some home state companies would be suited to being owned by better regulated out of state companies, such as in the case of ownership of hard assets. It should also be noted that some states, in a highly unconstitutional and oppressive manner, due to their own fiscal incompetence, will demand registration and payment of fees from any state resident with an out of state company, even if such a company is ‘virtual’ with no hard business presence in that home state. There are ways around this issue which this Firm is happy to discuss if you are a resident of such a state.
If your business has no “home base” so to speak, meaning no office, warehouse, or other concrete connection to your home state, with the business basically existing virtually online on your computer, then your best bet for an entity would generally be to base it out of Delaware. This is more or less the consensus among business law experts, and the fact is that Delaware houses the most companies by far than any other state, with most Wall Street funds making their home there bodes well in support of that assertion. Over a million businesses—more than 50 percent of publicly traded companies in the U.S. and more than 60 percent of Fortune 500 companies—are incorporated in Delaware; that should tell you something.
The laws are stable and predictable, it has well developed case law with strong protections for businesses, as well as no income tax on businesses that do not conduct business activities inside Delaware, although there are franchise taxes for keeping your legal entity in good standing (corporate franchise taxes are tricky). This particular state also has extremely beneficial entity formation requirements for asset protection purposes; in fact Delaware is the closest thing to being offshore without actually being offshore. Please note that generally speaking investment fund or capital raising entities should usually form in Delaware, as that is the preferred state for venture capital firms and many angel investors. The Delaware Statutory Trust is a one of a kind, highly flexible, legal entity that provides commensurate legal protections for all parties involved as other legal entities along with numerous other benefits, including 1031 transfer IRS compliance for real estate investors, which are perfect for holding hard assets or secured secondary market paper assets for beneficiaries/investors who will place their funds with the trust.
Another great state for corporations as well as LLCs is Wyoming: cheap formation, maintenance and beneficial business laws make this a great state for smaller companies and family companies. This is the first state to have passed laws allowing formation of LLCs in 1977. Wyoming is cheaper than Delaware, and has similar asset protection laws to Delaware, fully protecting single-member LLCs with a charging orders being the ‘sole’ remedy (creditors can only hold the order and wait to be paid, but cannot force distributions or foreclose on any membership interests). Another major draw is the lack of any state income taxes and franchise taxes on Wyoming legal entities; in fact, according to the new 2017 edition of the Tax Foundation’s State Business Tax Climate Index, “Wyoming has the most business-friendly tax system of any state,” for the seventh year in a row.
Within the past decade or so Wyoming has come out with Close LLCs, probably to try and add something new to the mix they could market. These entities restrict the transfer of interests, member withdrawal/resignations, return of capital, and there are a few additional legal mandates which make these entities a consideration for small private companies which are family owned; however, it should be noted that everything these new entities provide by law can also be drafted into a standard operating agreement by a competent attorney, and thereby become legally binding on all members.
Number 3 of the best states on this list would have to be New Mexico. This state would be number one on cost because there is only a $50 formation fee and no other fees or reports due ever again. It also has solid privacy protections, same as the above states: the members/managers do not need to be publicly disclosed in any documents. Additionally, NM tax laws are highly advantageous, same as the above states: if your company has no operations inside NM, then no taxes will be owed to the state. Note that residents of NM will owe taxes, just as with any other state.
However, what places this state at number 3 are its laws, which firstly do not have the historic association with business-friendly court rulings or extensive business expertise of the courts, as the states above. And additionally NM laws do not provide as strong asset protections as the above states, although their laws are decent. For example, a charging order is not expressly the “sole” remedy for a creditor; hence the possibility of foreclosure on a member’s interest and/or “piercing of the veil” are both more likely here. However, these types of issues can easily be dealt with in an operating agreement, for example by not permitting a creditor to become a member, by restricting creditor voting rights, by permitting the company to buy out the foreclosed member’s interest at a reduced price, and by means of other little tricks of the trade. Please contact this Firm to find out more; we handle a lot of these issues here.
The worst states for an LLC will follow in a separate post, but at this time it can easily be said that California, Nevada, and New York are definitely on that list. Yes, Nevada is no longer the LLC paradise it once was.