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Where to Form a Business

What are my considerations in determining in which state to incorporate?

Your state of incorporation depends on several factors, the most important of which are: 1) Where you conduct operations, 2) Tax considerations, 3) Legal considerations.

These factors will either mandate or give rise to a preference for incorporating within one state as apposed to another.  Below is an explanation of the individual considerations for the state of incorporation.

 

Where you Conduct Business

Any business that conducts business within a state must be registered with that state’s government. The business generally has the option to either incorporate within a state or incorporate in another state and register to do business within the state of operations.  This is a common situation when the corporate headquarters is one state, where operations takes place in one or more other states. Incorporating in a foreign state and registering in the state of business operations will give rise to dual business reporting and governmental fee requirements (permit and taxes). The State where a business carries on operations will also tax and require permits of the business. Likewise, the state has a duty to protect its citizens (i.e., regulate the business) from foreign corporations doing business within the state (corporate governance and legal liability).

 

Tax Considerations

The state where a business carries on business (i.e., produces income) will attempt to tax that income.  Most states have a state income tax for corporations, where a limited number of other states do not. Obviously, a lack of or reduced income tax rate may be extremely beneficial to a new business. A second tax consideration is the value of property owned or rented by the business and the applicable local property tax rate.  Often businesses will negotiate with either state or local governments for a reduced property tax rate or a non-cost, long-term, property rental in exchange for bringing business to the state.  The benefit to the state government is the creation of new jobs and other economic stimulus.

 

The first legal consideration regards the the likelihood that legal issues will arise for the business.  Some states have a well-developed body of business law. This is particularly important with regards to contract disputes between business.  For example, the chancery court of Delaware is extremely well versed in business law matters, such as those falling under the Uniform Commercial Code.  Further, judges are well versed in business matters and often hear business cases without the use of a civilian jury.  Many believe that the law in Delaware is slanted in favor of new businesses.  In reality, most Delaware corporations simply preferred Delaware in order to have an established and predictable legal system.

The second legal consideration is the potential civil liability of the business under the state’s tort law.  In fact, the tort law of a state can be a determining factor for whether to incorporate within the state.  Generally, a corporation may be sued either within its state of incorporation or where the cause of action arises. Incorporating in one state will subject the corporation to legal action within that state, regardless of where the cause of action arose. For example, if you conduct business in Georgia, but incorporate in Delaware, you can be sued in Delaware. This jurisdictional consideration can be very important. The business may wish to avoid the inconvenience or disruption to the business to be hailed into court in a foreign or distant state. Further, many states have cap on certain types of civil damages, particularly the award of punitive damages. The cap on potential damages can be a strong incentive to businesses that are prone to civil actions under state tort law.

The third legal consideration is convenience and ease of incorporation. Most states have a very easy and simple process for incorporation. Certain states take steps to attract businesses by simplifying and expediting the incorporation process. For example, the Delaware Secretary of State’s Office has a highly efficient and streamlined incorporation procedure. The laws of corporate governance follow the model rules and there are lots of corporate governance and compliance resources available to new businesses. The ease and speed of incorporation is becoming less important as a factor.  Nearly, if not all, states now allow a business to incorporate over the internet.

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