If you’ve launched your own consulting firm, your next step is deciding where to incorporate the business. Although you may have heard that it’s best to incorporate outside of your home state, many small businesses will find significant drawbacks to being incorporated in a state other than the one in which they primarily conduct their business.
In this article, I’ll take a look at the pros and cons of incorporating in your home state, based on taxes and fees, liability, shareholder rights, and other considerations.
Typical factors and fees associated with incorporating—anywhere
To make an informed decision about where to incorporate, you need to know what issues are important, so let’s start by discussing some of the criteria you should use to compare one state to another. The two broad factors you should use in comparing states in which to incorporate are corporate law and corporate fees and taxes. You may find it compelling to incorporate in one state versus another when one state has corporate laws that favor your type of business or your business goals. Of course, your company is still subject to the local laws of any place in which you have what’s called a business “presence,” but the corporate law of the state of incorporation will usually govern any suit brought against your company. (By the way, you should make this clear in an explicit clause in every client contract.)
Corporate law, taxation, and other factors set by the state of incorporation will vary from state to state, but these core issues deserve the most consideration in determining which state to call your corporate home:
- State taxes and fees
- Officer liability
- Stockholder rights
The first two issues are of concern to all potential corporations. The matter of stockholder rights is only a concern if you anticipate your business becoming anything other than a private, closely held corporation (one in which the shareholders are also the officers).
Common taxes and fees
Every state charges something for your organization to become and remain incorporated in that state. The type of charge, amount of money, and how often you have to pay it (one time only or annually) can vary. All states will require you to pay for one or more of the following:
- Setup fee: a one-time fee to incorporate in the state
- Franchise tax: usually an annual fee; some states collect it as a flat fee, while others may base it on the number of outstanding shares
- Annual report and registration fees: fees to compensate the state for filing the paperwork required from a corporation
- Income and stock taxes: taxes on your corporate profits and/or number of outstanding shares
When you form a corporation, you and your fellow officers can still be held personally liable for actions you perform through the corporation. Some states write their laws in a way that helps to shield corporate officers from certain kinds of liability, while others take a more strict approach.
Liability in this case isn’t just the kind you could incur by, say, accidentally setting a client’s office on fire. In some states, such as California, you can be held personally liable for an action that is not in the best interests of the corporation—and shareholders or fellow officers can sue you. Again, the importance of this issue will depend on the nature of your business, how many shareholders you have, and your relationship with your fellow officers.
Do you plan to go public?
If you plan to take your company public, you’ll have different priorities than if you intend to remain a privately held company. In that event, you’ll want to be concerned with shareholder protections, such as their right to inspect your records. What reason(s) must a shareholder provide in order to see your records? Can someone who owns one share examine your financials, or must a shareholder hold at least a certain percentage of outstanding shares to be extended that right?
In addition, if you hope that your company will one day have a large number of stockholders, you should also consider the state’s protection against takeovers. Some states do more to protect a company’s officers from being replaced without consent than do others.
When is it best to incorporate in your home state?
Whether you’re attracted to incorporating in another state because of its laws or its low financial charges, you should first find out whether incorporating there really gets you off the hook in your home state or whether it just doubles your obligations.
If the following scenario fits you, it will probably make more sense—both financially and in terms of required upkeep—to incorporate in the state in which you conduct business.
- You don’t plan to go public, at least not while the company is under your ownership.
- You don’t conduct business in more than one state. (Traveling to another state to meet with a client doesn’t count in this case, as long as most of the work is actually performed in your home state.)
- You plan to limit your officers to yourself and a minimum number of other people.
Even if you don’t fit all of the above conditions, these other few strikes against incorporating anywhere but your home state may influence you:
- You will not avoid paying income taxes in the state where you conduct business.
- Depending on the laws of your home state, you may have to pay corporate taxes in both states.
- Many states require you to apply to do business in their state—a process called “qualification”—if you aren’t incorporated in that state. The application and filing fees can cost as much as it would have to incorporate there.
- You may be bound by many or all aspects of the corporate law in your home state even if you don’t incorporate there.
- You must maintain a registered agent (a person designated to receive tax notices, court papers, etc.) in the state in which you are incorporated. If this is your home state, you can be the registered agent. If not, you’ll have to pay a service to act as your registered agent—you can’t use a post office box address.
Still thinking about incorporating in Delaware?
Delaware has come to be thought of as a corporate haven, mostly because of the protections it affords large companies.
Delaware corporate law attempts to protect the interests of shareholders and requires corporate directors to act according to an objective standard. Contrary to popular opinion, you do have to pay certain fees and taxes for incorporating in the state. Although its setup fees are comparatively low, you have to pay a franchise tax based on the number of outstanding shares; $30 is the minimum.
While that may not sound like much, add that to Delaware’s annual filing fees, state corporate tax (if you don’t pay state tax in your business state), and any fees you pay to qualify in your own state. Filing in Delaware may have some advantages for you if you hope to make it big. However, it isn’t automatically the right choice for small, or even midsize, companies.
Up and coming: Nevada and Wyoming
As a note of interest, Nevada and Wyoming are attempting to appeal to those companies that Delaware doesn’t help. If you do need to incorporate somewhere other than your home state, perhaps because you do business across several states, you may find that one of these states is as good a place as any to incorporate.
Neither Nevada nor Wyoming collect state corporate income tax, franchise tax, or tax on shares. They allow you to form a corporation without naming other officers or directors, meaning that you can continue as a one-person operation if you wish. Both states are geared toward protecting privacy and sheltering officers from liability rather than defending shareholder rights.
Meredith Little wears many hats as a self-employed technical and travel writer, documentation consultant, trainer, business analyst, and photographer.If you’re based in the United States, where is your consulting firm incorporated? Why was this state chosen? Post a comment below or send us a note.