Factors to Consider When Choosing a State for Incorporation
Startup Issues to Consider When Selecting a State
Some of these issues may be important to your corporation. In any case, they can serve as a starting point for questions to ask.
1. How many incorporators are required by the state, and whether the incorporator itself can be a corporation.
2. The minimum number of people required to form the corporation.
3. The minimum capital requirement, if any.
4. The state’s fees for filing the articles of incorporation.
5. The state’s annual corporate franchise tax.
6. The state’s corporate income tax and whether earnings from operations outside the state are taxable. The State of Delaware taxes non-Delaware resident shareholders of S corporations on their distributive share of S Corporation income based on the percentage of that income derived from Delaware sources. If a Delaware corporation has no Delaware source income, these taxes should not be an issue.
7. Whether the corporation is allowed to keep its books and records outside the state.
8. The state’s court system’s reputation of fairness in business cases.
9. Whether the corporation is allowed to have its principal place of business outside the state.
10. Whether there is a state inheritance tax on non-resident shareholders.
11. Disclosure/privacy – whether the state requires public disclosure of the names of shareholders.
12.Whether the state requires a corporate bank account in that state (Delaware does not).
Nevada Corporation vs. Delaware Corporations
Historically, Delaware has been the state of choice for incorporation. However, some other states such as Nevada have shaped their corporate laws in order to attract corporations. Here is how Delaware and Nevada compare on several points:
1. Taxes on corporate earnings: Delaware taxes the proportion of corporate profits earned in Delaware. Nevada is tax-free, regardless of where the profits are earned.
2. Annual franchise tax: Delaware and most other states have an annual franchise tax on corporations. Nevada does not.
3. Annual disclosure: Delaware requires an annual report of stockholder meeting dates, business locations outside of Delaware, and the number and value of shares issued. Nevada requires only the current list of officers and directors. In both Delaware and Nevada, the officers and directors can be one person.
4. Protection of officers and directors: Nevada provides broader protection against personal liability of officers and directors than does Delaware.
5. Shareholder disclosure: Nevada and Wyoming are two states that allow bearer shares. When corporations first came into existence, their stock certificates were like cash in the sense that whoever was holding them at the moment legally was the owner. However, in order to protect their shareholders against theft of the stock certificates, corporations began to maintain a stock ledger listing the shareholders. Eventually, the stock ledger became the authoritative record of the shareholders, and when stock was transferred it would have to be recorded in the corporation’s stock transfer ledger. Most U.S. states no longer permit bearer shares, with the notable exceptions of Nevada and Wyoming. Since bearer shares legally belong to the person holding them at the moment, the holder of bearer shares truthfully can deny ownership in the corporation if he or she does not hold the certificates. Bearer shares often are used for illegal purposes, such as tax evasion. They also are used for asset protection, which by itself is not illegal, but which often results in illegal actions when bearer shares are involved. For example, if you hand your bearer shares over to somebody else so that you can truthfully deny owning them in the future, gift tax is due on the transaction. Furthermore, when the other person ultimately hands them back to you, gift taxes are due again. While bearer shares might have a few legitimate uses, in general it is best to avoid them, so whether or not a state permits them probably should not be a major criterion in the decision of where to incorporate.
6. Disclosure to IRS: Delaware and most other states share tax information with the IRS. Nevada does not. As with bearer shares, non-disclosure to the IRS attracts those seeking to illegally evade taxes, so this should not be a criterion for legitimate business purposes.
There is a flip side to some of Nevada’s perceived advantages. Some companies attempt to take advantage of Nevada’s laws in order to evade taxes. As a result, Nevada corporations are more frequently audited by the IRS than are corporations in other states. In this regard, however, the state of Wyoming has most if not all of the advantages that Nevada has, but a lower audit rate, at least for now. There also are other intangibles to consider. For example,if you incorporate in Delaware instead of Nevada, your corporation may be seen as having slightly more credibility in the eyes of those who know about Nevada’s corporation laws. This issue may have little or no ground, but it at least is worth considering.
Regardless of the state in which your business incorporates, the state in which it is operating probably requires it to register as a foreign corporation in that state. In addition to registration fees, the corporation typically would be subject to the same types of reporting and taxes as would any corporation in that state. If a corporation does not register as a foreign corporation in a state, it may not be allowed to bring action in the court system of that state, and may be subject to the taxes and fees that it would have paid had it been registered. Fines also may be imposed. Because of the requirement to register as a foreign corporation, most of the anticipated advantages of incorporating in a state that offers more favorable laws might not be realized.