Incorporating a business is a smart way to reduce individual liability by creating a separate business entity. There are three types of incorporations: S-corp, C-corp, or an LLC. Each one of these options has its own set of benefits and drawbacks. Once you’ve decided on the structure that most benefits your organization, you still have to decide where to incorporate your business.
Incorporation laws are state-level legislation, which means that each state can make its own laws about the requirements, fees, and tax responsibilities for businesses incorporated within that state. Your experience will vary depending on the state you choose to incorporate in.
You don't have to incorporate your business in the state you live or work in; the state you incorporate in is completely up to you. If your business only does business in its home state–– think in terms of a brick and mortar store with only face-to-face business, a restaurant, a landscaping company with a service area only located in one state, etc.––it is generally best to register in that state. But in some cases, it might be worth it to register in another state, especially for online businesses or those that do business in more than one state.
Incorporating your business creates a separate business entity from you or your partners. Even though there are costs associated with incorporating outside of your home state, if the other factors are favorable to your business, you might make out better in the end.
Whether you are considering incorporating in your own state or looking at your options for other states, there are a number of factors that are going to determine whether you have a smooth or bumpy ride. The best state to incorporate in is determined by the formation fees, annual filing fees, taxes, and legal structure. We’ll go through each one of these paying special attention to which states rank high for each category and which ones bring up the rear.
- Best States for Formation Fees: Arkansas, Colorado, Hawaii, Iowa, and Mississippi
- Worst States for Formation Fees: Connecticut, Texas, and Massachusetts
Let’s start with the first costs associated with incorporating a business: the formation fees. These are the one-time fees you pay to the state when you apply to incorporate your business there. Filing fees vary by state and you can find the most current requirements on each state’s Secretary of State website. Keep in mind that these are in addition to any fees your lawyer or facilitator may charge to prepare and file your paperwork.
How much the formation fees factor in your decision to incorporate in a state depends on how much the start-up costs matter to you. If you’re counting every penny during startup, the formation fee may be a very big deal. But, it’s also only a one-time fee, so the long-term effects on your bottom line are minimal. In most cases, formation fees are less of a factor than filing fees.
Formation fees can range from $50 to $455. The states with the lowest formation fees are Arkansas, Colorado, Hawaii, Iowa, and Mississippi. The ones with the highest fees are Connecticut at $455, Texas at $310, and Massachusetts at $295.
Annual Filing Fees
- Best States for Annual Filing Fees: Alabama and Ohio
- Worst States for Annual Filing Fees: Nevada, District of Columbia, and Maryland
The formation fees are just the beginning of costs required to incorporate your business. Each year you will also be required to file a one-page report with a filing fee, which will vary depending on the state. (In some states, it’s actually required every two years and is therefore called a biennial report.) This report is to keep the state informed about any changes in your business, including the principal address, authorized signatories, and the number of stocks issued by the business.
Currently, the only states that don’t require regular filings are Alabama and Ohio. Over the course of the life of your business, you can save a lot in terms of money and time from not having this yearly obligation. On the other end of the spectrum, Nevada has the highest annual filing fee, topping out at $325. The District of Columbia has a $300 fee. Maryland’s filing fee is based on business income but the minimum is $300.
- Best States For Corporate Taxes: Nevada, Wyoming, and South Dakota
- Worst States for Corporate Taxes: District of Columbia, New Jersey, California, Minnesota, and Rhode Island
Taxes are a huge factor in determining the best state to incorporate in. The less you pay in taxes, the more your business can keep for running costs and profit. There are three types of taxes to consider—state income taxes, corporation taxes, and franchise taxes. State income taxes affect businesses in S-corp structure because the owners pay taxes based on their distributive share of ownership through their personal income taxes. Corporation taxes are levied on C-corp. LLCs might be affected by either type of taxes. Franchise taxes are for the privilege of operating and existing within a state that recognizes these types of taxes.
Nevada, Wyoming, and South Dakota all rank high for best tax laws because they do not have state income tax or corporate taxes. However, keep in mind that this only works for businesses that operate within those states. While you might incorporate there, if you operate your business in another state you will still be subject to that state’s tax laws. On the other hand, the District of Columbia has some of the highest personal and corporate income taxes in the country. New Jersey, California, Minnesota, and Rhode Island are not far behind.
The main difference between franchise tax and income tax is that franchise tax is not based on money earned by the business. Depending on the state, it might be based on a business’ net worth, gross receipts, or even margins. There are also generally minimum tax owed regardless of the factors your state uses in calculations. So, your business could possibly lose money but you would still owe a hefty franchise tax. Currently, there are fifteen states that still have franchise tax laws on the books, including New York, Mississippi, and Georgia.
- Best Legal System for Corporations: Delaware, Nevada, and Wyoming
- Worst Legal System for Corporations: Mississippi and New Mexico
The corporate laws in a state can affect the experience of owning a business there. Delaware, for example, is known for having the best business laws in the country. The state has a Court of Chancery, which hears corporate case laws instead of a jury of citizens. This is completely unique to Delaware. Corporate cases are handled more quickly and more efficiently there. You will be dealing with a court that is only handling business manners instead of waiting for your case to be seen on a general docket. You will also be in courtrooms with judges who are well-versed in business law and procedures. The result is that legal costs can be much lower in Delaware than in a state with less business-friendly laws.
Since Delaware has become known as the most corporate-friendly state in the country, it has become one of the most desirable states to incorporate in. In fact, the Delaware Division of Corporations claims to be home to 66 percent of the country’s Fortune 500 companies. Many serial investors will insist that a business is incorporated there before cutting you a check. The reason is that the overall risk is much less where the business laws are predictable and favorable.
Delaware has some competition, though. Both Nevada and, more recently, Wyoming are becoming well known for the same legal benefits for corporations. On the opposite side of the fence are those states that aren’t quite as business-friendly in their legal structure. According to a 2017 CNBC roundup of best and worst states for businesses, New Mexico and Mississippi both ranked very low on the list for business friendliness.
The Bottom Line
These factors can all have long-term effects on the success of your business so it is important to at least consider them when making the decision on where to incorporate. But ultimately, the best state to incorporate in depends on where your priorities lie. If you are courting investors or considering your legal options, the legal structure is the most important factor. Or maybe you’re forming an S-corp and so personal income taxes will make a huge difference in your yearly expenses. Are you worried about the potential costs associated with yearly obligations of filing in a certain state? Then the annual reports and filing fees will be your priority.
No matter what your perspective might be, do your due diligence on the state you are considering for your corporation. The first place to check is the state's individual Secretary of State website for your rights and responsibilities under current legislation. There you will be able to get the information straight from the horse’s mouth. You will also find answers to frequently asked questions and contact information for getting more in-depth answers. And as always, it’s a good idea to get the advice of a legal representative who can give you professional advice and guide you in making the right decisions for your business.