2023-11-14 08:00:00
After you’ve decided that a limited liability company (LLC) is the best business entity for your company needs, you might be wondering which is the best state to form an LLC. You might think the only option is to file in the state where you live, but that’s not the case, nor is it necessarily the best choice for every LLC. This is especially true if you live in a state like California that has expensive filing fees and annual reporting obligations.
Whether it makes sense to start an LLC in the state where you live or in a different state depends on the type of business you have and the income you expect to generate. This guide will take you through the decision-making process, common misconceptions and your most frequently asked questions.
Overview of the LLC Structure
Many entrepreneurs choose to form officially as an LLC because of the tax benefits, personal liability protection and flexible management structure it offers. Unlike corporations that are “double-taxed,” (they pay corporate income tax and the shareholders pay personal income tax), LLCs are designated as “pass-through tax entities” by the IRS. That means the company itself doesn’t have to pay taxes. Instead, the income is passed through to the members and they pay self-employment taxes.
Domestic LLC vs. Foreign LLC
When business owners choose to formally organize as an LLC and file the appropriate documentation (usually called the articles of organization) within the state where they conduct business, a “domestic LLC” is formed. That said, states want to have a thorough and complete record of the companies conducting business within their borders, even if the company is headquartered out of a different state. So, following a business forms a domestic LLC in one state, it might want to expand its business into a second state, or several other states. In each of the additional states, that LLC would need to register their LLC as a “foreign LLC” with the appropriate state agency.
It’s a common misconception that a foreign LLC is a company formed outside of the United States or is formed by a non-U.S. citizen. However, it’s really just a term for an LLC that’s formed in a different state but conducts business across interstate borders, not internationally.
To clarify, you don’t need to start a foreign LLC in a different state just because your company sells a product to a patron in that state. However, if you start a store in that state and conduct business then you will need to start a foreign LLC there. For more context, common reasons you’ll need to start a foreign LLC include:
Establishing a presence in the new state (office space, storefront or storage facility)
Hiring workers in the new state
Holding regular company meetings within the new state
Getting a business license from that state to conduct activities
Which is the Best State to Form an LLC?
The reason this consideration comes up is because small businesses are trying to figure out the best way to decrease taxes and startup and operating costs. You might be tempted to choose a “business-friendly” state with cheap filing and annual fees or a state with no income tax. However, that’s not necessarily going to save your business money.
Despite this speculation regarding decreasing the amount you’ll pay in taxes or cheaper filing fees, if you have no intention of physically relocating your business to a different state, then the best place to form an LLC is in your current state. When it comes to taxation, you’ll need to pay taxes in every state in which you earn money. So, even if you start an LLC in a state that has no income tax, if you are operating your business from a state that doesyou’ll need to pay taxes in that state.
Number 1 Choice: Home State
Regardless of where you currently reside, if you have no intention to move your business elsewhere, that state will be the best state in which to form your LLC. Otherwise, you’ll need to pay for and maintain more than one LLC and possibly pay taxes in more than one state to be legally compliant. The “home state” is where the business’s activities will be conducted, money will be made and members will gather for company meetings. Although that means most business will be conducted where the member(s) reside(s), that’s not always the case — specifically if there are multiple members who live in different states.
For example, if four friends who each live in different states start and run a store that operates out of California, then the appropriate state in which to form their LLC would be California. If the four friends each decide they want to open their own franchise of that same store in the state in which they live, then they’ll have to register a foreign LLC in each of those additional states.
To learn more regarding starting an LLC in your home state, see our state-specific guides at the end of this article.
Number 2 Choice: Wyoming
If you’re looking to relocate and start your new business, Wyoming is a great choice. Not only is it the first state to make LLCs a legal business structure in 1977, but Wyoming also has no state income tax, a cheap sales tax rate which currently sits at 4% and a relatively inexpensive LLC filing fee of $100.
Wyoming also has very protective privacy laws. Unlike other states that make the contact information and member information of every registered business part of the public record, Wyoming allows this information to be anonymous. Wyoming might be the least populated statebut there are still opportunities to be taken advantage of, and patrons who can utilize what your business has to offer.
Number 3 Choice: Delaware
If you’re looking to move somewhere new and are thinking you may want to upgrade to a corporation at some point in the future, Delaware is a good choice for your LLC. Like Wyoming, Delaware has privacy laws in place to protect the members of every LLC from being disclosed to the public.
The cost to file your organization documents with the state is only $90 for domestic LLCs and is $200 for foreign LLCs. You’ll also need to pay a $300 state tax fee each year, but you won’t need to file any annual reports to remain compliant.
The reason we elected Delaware as the number three choice is because if an LLC has interest in later changing to a corporation (known as incorporating) this is a great state in which to do it. While there are no specific laws that make it more suitable for LLCs than other states, Delaware is the state of choice to incorporate because of their business-friendly corporate tax laws. There’s a reason why 66.8% of all Fortune 500 companies choose Delaware as their incorporation state.
Overall Considerations When Choosing a State for LLC Formation
Starting your LLC in the place where your business is located is by far the most logical and cost-effective choice. If you start an LLC in a state where you only conduct some of your business, you’ll still end up having to register as a foreign LLC within the state where you conduct your remaining business. That means you’ll pay double the fees and sometimes double the franchise taxes. On the other hand, if you’re looking to start somewhere new to build your business, then it makes sense to look for a state that has a low start-up cost (low filing fee, low licensing fee, no state income tax, etc.).
LLC Formation Companies
Are you thinking of using an LLC formation service to start your business? See how the top LLC formation services compare in price, quality and service offerings. As always, we encourage you to do your own independent research to determine which provider is best for your needs.
50 State LLC Formation Guides
Interested in starting an LLC? Below are the links to our all-inclusive, state-specific LLC formation guides.
Legal Disclaimer: This article contains general legal information but does not constitute professional legal advice for your particular situation and should not be interpreted as creating an attorney-client relationship. If you have legal questions, you should seek the advice of an attorney licensed in your jurisdiction.
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