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Where Should You Form Your Entity?

November.25.2009

When forming a new LLC or corporation many contemplate whether it’s better to form their entity in their home state or in another, such as Delaware or Nevada.  For most small businesses, the best state for formation is its home state.

Many believe their businesses will receive tax or legal benefits for forming in an alternative state, and legal document mills often perpetuate these beliefs to sell incorporation packages… While some businesses benefit from the differing tax laws of other states, the vast majority of small business realize no benefit and forming in another state only creates financial and administrative burdens. For instance, many sell Nevada as a place to incorporate since there is no corporate income tax, but most businesses will not be able to legally take advantage of that tax difference. In addition, your home state often provides adequate legal attributes and liability protections for your business, despite the often promoted liability protection benefits of having a Delaware entity.

Most major corporations choose to register their companies in a handful of states, and this sometimes creates the perception that companies are doing so solely to limit their tax liabilities. Often these decisions are based upon those states’ corporate governance requirements, meaning certain states do not impose many requirements on how a company must be run or funded. Start-up companies that anticipate selling stock to the public often form in Delaware. Other states provide benefits to companies in certain industries, such as the lax usury laws that may attract banks or credit card companies. This does not necessarily mean, however, that the average small business will receive any benefit by following the lead of these corporations.

For tax purposes, if your company operates in Maryland, then it will be required to file a Maryland income tax return in Maryland. Further, the company’s income that originates in Maryland must be reported on the Maryland tax return as Maryland income. The Maryland tax return must be filed regardless of the state that the company chose for formation or incorporation.  Therefore, unless your company has operations in multiple states, then your company usually has no tax reason to form outside its home state.

A small business registering in another state will run into several problems. First, even if the company is registered in another state, most state’s require the business to also register as a “foreign business” in their state and pay the associated fees. Second, the state may also require the company to obtain an in-state mailing address and hire an in-state person to be the company’s “registered agent”. Unless you have a contact living in the state, then you often will need to pay the local person to perform these duties. Finally, by registering in another state, you may find yourself being sued in that state’s courts. Your registration state’s courts will have jurisdiction to accept a lawsuit filed against your small business and may require you to defend your company in a very inconvenient or unfriendly location.

In conclusion, unless you can identify a specific benefit of being registered in a certain state, then you should generally choose to register in your home state. Few businesses benefit from forming in another state. Further, filing in another state may cause you to incur substantial costs and many administrative and legal burdens.  You should certainly consult your attorney before making a choice that may be very costly to reverse.

For further information regarding forming a business entity, please contact Jeff Rogyom at (410) 929-4578.  Please review the Disclaimer page regarding use of this website and its information.

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