Forming a Wyoming vs. a Delaware LLC
If you’re thinking of forming an LLC, you’ve probably seen information about why forming it in Wyoming, Delaware, or another business-friendly state like Nevada is a good approach.
These states have reputations as especially attractive to business owners for some legitimate reasons, but, unless you plan to operate your LLC in one of these states, you’re unlikely to reap the benefits.
- Domestic vs. Foreign LLCs: An important reason to avoid registering your business outside your home state is the domestic vs. foreign LLC framework. No matter where you form your LLC, you must always register (and pay fees) in any state where you conduct business activity. Your business will be considered a domestic LLC in its state of formation and a foreign LLC in all other states in which it operates.
- Taxes: Although some of the most business-friendly states boast low — or no — income tax, these attractive tax codes only apply to income generated within those states. You may form your LLC in Wyoming with the hope of avoiding income taxes on your business earnings, but, if you make all of your money in California, that’s where your income will be taxed.
Wyoming is considered the birthplace of the LLC. It was the first state to recognize this business structure in 1977. Since then, the state has maintained an extremely friendly environment for small business owners. Specifically, Wyoming offers:
- Tax Benefits: The state levies no income tax or franchise tax and charges an annual reporting fee of just $50. The state sales tax also falls below the national average at 4%.
- Privacy Protection: The state also provides privacy protection by not requiring the public record to include the names of LLC owners.
Delaware also has a strong reputation as a business-friendly state for two key reasons, including:
- Privacy Protection: Delaware is one of four states in the country that allow LLC owners to remain anonymous. This can appeal to business owners who prefer to avoid any public association with the actions of the business or those who want to maintain a low profile.
- Legal Protection: Delaware has a special court system — the Delaware Court of Chancery — designed specifically to handle corporate legal disputes. The judges on this court specialize in corporate law and hear cases without juries, creating a particularly business-friendly legal environment.
Finally, a discussion of business-friendly states must include Nevada. Touted as one of the best states in which to form an LLC, Nevada also offers:
- Tax Benefits: Nevada has no state taxes. That includes corporate income tax, personal income tax, and franchise tax.
- Privacy Protection: Like Wyoming and Delaware, Nevada doesn’t require LLC owners to list their names when forming a business, which allows for anonymity. Nevada goes a step further by also not requiring companies to list their assets at the state level.
Why It’s Best to Form an LLC in Your Home State
Although Wyoming, Delaware, and Nevada offer excellent benefits to business owners, it’s still almost always best to form your LLC in the state where you do business. This is because most of the benefits these three states provide extend only to companies operating within their borders.
Domestic vs. Foreign LLC: Which Are You?
The classification of your business as a foreign or domestic LLC will depend on where you formed the business and where it operates.
- If you form and operate your business exclusively in one state, it’s automatically considered a domestic LLC in that state.
- If you choose to do business beyond your LLC’s state of formation, you must register your company as a foreign LLC in each additional state where you conduct business activities.
This framework is one of the primary reasons why registering your LLC outside your home state doesn’t make good business sense.
For example, consider a business owner living in California where business registration and maintenance fees are well above the national average. Seeking a more friendly business environment, this owner chooses to form their business in Wyoming where fees are low. This business is, therefore, a domestic LLC in Wyoming.
Because the business operates in California, the owner also must register it as a foreign LLC in that state. That will subject it to California’s registration fees. As a result, this business owner had to pay two registration fees and will face annual reporting fees in two states. Additionally, because they don’t physically reside in Wyoming, the owner also must pay to set up and maintain a registered agent in that state.
Business Tax Implications
Beyond business registration and maintenance fees, states generate a great deal of revenue from business taxes. For this reason, attempting to skirt these liabilities rarely succeeds.
The California business owner cited above likely found Wyoming attractive for its lack of personal income taxes as well. Given California’s 13.3% income tax rate, many California-based entrepreneurs may seek ways around paying business taxes in their home state.
But, that’s a losing strategy.
Because this hypothetical business makes all of its money within California, the owner must report all business income on his California tax return. Wyoming’s tax rules would only apply to income made within that state.
In this example, the California business owner reaped no benefits from Wyoming’s favorable business environment. Instead, he expended more time and resources than he would have by forming his business in California.
Consequences of Not Reporting Business Activity
Given the complicated nature of state business regulations, entrepreneurs may find compliance challenging and may look for ways around them. A business may be unaware that it must register as a foreign entity in its home state after forming out of state, for example, or may willfully decide not to register or properly report income generated in a state with higher taxes.
Situations like these will, ultimately, result in negative consequences like:
- Financial Penalties: Beyond general penalties imposed for failure to pay personal income taxes, California imposes a $2,000 annual penalty on out-of-state LLCs that conduct business in California without filing the annual franchise tax forms. While the state’s $800 annual franchise tax may seem excessive, the penalty makes it well worth complying.
- Legal Penalties: In addition to fines and fees, states also will strip noncompliant businesses of critical business rights and benefits. In California, for example, unregistered businesses risk having the state nullify all contracts they create. Other states strip businesses of the right to bring litigation against wrongdoers if they aren’t properly registered in the state.
For these reasons, LLC owners should do all they can to remain compliant in every state in which they do business. Registering your business in as few states as possible makes it much easier to operate within these rules.
Does It Ever Make Sense to Form an LLC out of State?
Because there are exceptions to every rule, you may wonder who actually benefits from forming an LLC outside their home state. With all the hype around this issue, some scenarios must exist in which forming an LLC out of state makes sense.
While larger corporations or businesses with above-average liability concerns may consider forming in one of the states listed above in some situations, there are almost no circumstances in which your small business will benefit from this practice. The one exception concerns real estate investors per the reasons discussed below.
The Best State to Form an Internet-Focused LLC
If you run a business entirely online you may wonder how this will affect where you should form and register your business. The short answer: It doesn’t. If you’re based in California and sell your products or services entirely online, you’re a California business that will pay income taxes in California. As such, you need only register your business in California.
Although you receive payments from people across the country, this income comes to you in your home state via deposits into a bank account in California. While regulations surrounding sales tax and online business continue to evolve, your home state rules when it comes to your personal income tax. There’s no benefit to forming your business outside your home state or registering as a foreign LLC in any additional states.
The Best State to Form a Consulting-Focused LLC
Many small consulting businesses operate exclusively online, offering services remotely. These businesses are treated the same as any online business for registration and tax purposes.
But, what if you travel around the country providing services to people and businesses in multiple states?
If you physically do business in multiple states, you must register in each state in which you have a business connection. Because this almost always includes your home state, forming your business in the state where you live makes sense. The states where you maintain a business connection may vary over the life of your LLC, but your home state likely will remain constant.
The Best State to Form a Transportation-Focused LLC
Like consulting firms, transportation companies also may conduct business across state lines. Whether you run a taxi service or a trucking company, it can be hard to know where you should form your LLC. Again, the best choice is your home state because it’s the center of your business activity.
If your trucking business operates out of New Jersey, for example, it may be tempting to form your business in Delaware even if you don’t plan to conduct business there. This approach will not only inflate your costs by adding additional formation and maintenance fees but also can affect your compliance with state and federal Department of Transportation (DOT) guidelines.
Both the federal government and several states require certain transportation businesses to carry DOT numbers. The application and approval process for these numbers can grow complicated if you form your company outside your state of residence or the state in which you primarily do business.
The Best State to Form a Real Estate-Focused LLC
When it comes to LLC formation, real estate investment is the one exception to the strong rule of forming your business in your home state. Why? Because the business activities and income generated from real estate is almost always confined entirely to the state where the property is located. For this reason, forming an LLC in the state or states in which you own property is the best option to limit costs.
If you live in New York and own a rental property in North Carolina, for example, all of your business activities occur in North Carolina. Forming your LLC in North Carolina means you’ll only need to pay formation fees, maintenance fees, and state income taxes in one state. This remains true for investors who own properties in multiple states.
Now you’re in the know. Follow the link, choose your state, and start forming your LLC today.
Frequently Asked Questions
What is the cheapest state to form an LLC?
The cheapest state in which to form your LLC is always the state where you do business. While several states may offer lower formation fees, lower annual reporting fees, and lower-income taxes than your home state, these fees will only add to the cost of registering and maintaining an LLC where you conduct business.
Because you must pay taxes in the state where you generate your income, attractive tax codes elsewhere offer no benefit to your LLC.
Why is Delaware the best place to form an LLC?
Delaware offers a number of perks to business owners operating within the state. Privacy and legal protections create an appealing, business-friendly environment. Yet, these perks tend to suit large corporations more than small businesses. That makes Delaware a very popular corporate destination.
Delaware’s perks offer little benefit to small business owners. Unless you live and do business in Delaware, the laws of your home state will still govern your LLC while you continue to pay Delaware’s hefty $300 annual franchise tax.
Do I need to form an LLC to run an online business?
No matter what type of business you run, forming an LLC is a great way to legitimize your company and protect your assets. Because an online business only requires formation in your home state, getting the added protection of an LLC is a simple and cost-effective option.