Why You Shouldn’t Form an LLC in Delaware

If you live and run your business in Delaware, then Delaware is an excellent place to form an LLC.

And even if you live elsewhere but conduct a portion of your business in Delaware, or maintain real property in the state, then Delaware is an excellent place to form an LLC.

But for everyone else, the hype surrounding Delaware-based LLCs is just that: hype. While several states — including Delaware — boast more favorable business climates than others, it’s a common misconception that any business formed in these states will always reap these benefits.

Read our Best State to Form an LLC guide to learn more about this topic.

5 Reasons Why You Shouldn’t Form an LLC in Delaware

For small business owners, being from Delaware is a great bonus. The state offers strong privacy protection, a business-friendly court system, and has below-average personal income tax rates.

And if you live elsewhere but conduct a portion of your business in Delaware, or maintain real property in the state, then Delaware might be an excellent place to form an LLC.

But for everyone else, the hype surrounding Delaware-based LLCs is just that: hype.

And here’s why:

1: You Still Need to Register Wherever You Do Business

Since LLCs are governed at the state level, you must always register (and pay fees) in every state where you actually conduct business activity, no matter where you form your LLC. In order to make this work, states distinguish between domestic and foreign LLCs.

What is the difference between a domestic LLC and a foreign LLC? Your business is considered a domestic LLC in its state of formation and a foreign LLC in all other states where it’s registered to do business.

While you can form and maintain a domestic LLC in Delaware, you are legally required to register as a foreign LLC in every other state where you do business.

If you do not do business in Delaware, this means filing a Certificate of Formation, hiring and paying a Delaware registered agent, and paying both formation and annual fees — all to maintain an LLC in a state where you are not required to be registered.

To learn more about starting an LLC in your home state, check out our How to Start an LLC guides:

2: Delaware Carries High LLC Fees

There are several reasons why Delaware maintains such a favorable reputation amongst business owners, but Delaware’s formation and maintenance fees do not rank among them. To form your LLC in Delaware, the state requires a $300 formation fee. This is one of the highest LLC formation fees in the country.

Delaware also charges an annual franchise tax of $300. This tax applies to even those businesses not generating income in the state of Delaware. Only California, Nevada, and Massachusetts carry higher annual LLC fees.

If you do form an LLC in Delaware and later decide to dissolve the entity, Delaware charges a $200 fee just to file your dissolution paperwork with the Secretary of State.

3: Delaware’s Privacy Protections Are Only as Good as the Least Protective State Where You Do Business

One of the major factors cited in Delaware’s positive business climate is its strong privacy protection. While some states maintain personal data on business owners as a public record, Delaware protects this information.

What is an anonymous LLC? An anonymous LLC is an LLC that may be formed and maintained without disclosing the business’s members or managers. Only four states — Delaware, Nevada, Wyoming, and New Mexico — allow for truly anonymous LLCs.

When filing formation documents, Delaware only requires business owners to list the entity name and the name and address of the LLC’s registered agent. No information about the members or managers is required to be listed.

While this is an attractive benefit to many, this privacy protection is eroded if you do business outside of Delaware. What purpose do Delaware’s privacy laws serve if you must register as a foreign entity in a state or states without the same level of protection? In this scenario, you are paying Delaware $300 a year for protection that you cannot enjoy.

4: Delaware’s Court of Chancery Probably Won’t Take Your Case

One of Delaware’s most unique features is the existence of its Court of Chancery. Designed specifically to handle corporate legal disputes, the judges sitting on this court specialize in corporate law and hear cases without juries, creating a particularly favorable business climate.

What does the Court of Chancery handle? Delaware’s Court of Chancery handles matters of equity, including corporate matters, trusts, estates, and other fiduciary matters. This court also handles disputes involving the purchase and sale of land, questions of title to real estate, and commercial and contractual matters in general.

Like all of Delaware’s business-friendly policies, this court is an excellent resource for Delaware LLC owners who live and do business in the state. However, for businesses formed in Delaware and operating elsewhere, access to the Court of Chancery is not guaranteed.

A 2018 opinion in the Delaware Court of Chancery stated that the “mere formation of a Delaware entity, without more, is insufficient for this Court to exercise jurisdiction.” In order for businesses to bring litigation in the Court of Chancery, they must typically show a more substantive connection to the state than simply having been formed there.

5. Delaware’s Tax Rate Only Applies to Income Generated Inside the State

Although not necessarily a deciding factor in choosing to form an LLC in Delaware, the state’s lower-than-average personal income tax rate may still be seen as a benefit to those living in higher-tax states like California or New York.

However, taxes are due not where your business is registered but where your income is generated. For example, if you form your LLC in Delaware but all of your money is made in California, your income is subject to California income tax. No matter how attractive another state’s tax code may be, there is no getting around paying taxes in the states where you operate.

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