Foreign Qualification: Which State to Choose and Why

If you do business in one state, why would you want to incorporate in another state? The most common reasons have to do with privacy, possible future investments and costs.  But, do you know what state makes the most sense for you? First, consider whether filing in an out of state jurisdiction is right for you and then, if so, which one.  

Does it really save money?

The short answer is that you are not likely to save money by filing in another state. The filing fees in your home state may be expensive, but if you file in state X and operate in state Y, you may end up having to pay fees in both states. Every state charges for initial formation fees and fees with annual statements. So, you will owe some fees regardless of the state you chose.   

In addition, you will likely have to foreign qualify in the state where you actually operate. That involves filing fees for the initial foreign qualification and then yearly reporting and filing with the related annual fees. As a result, you would pay two sets of fees and therefore would not likely save on the filing fees by forming in another state.

Moreover, if you incorporate in another state, you will have to hire a registered agent in that state. The registered agent is the person or company that accepts lawsuits and governmental notices on your behalf. If you incorporate in your home state, you can serve as your own registered agent if you don’t mind your address being public record and being served with possible lawsuits at your home or office. You can choose to hire a professional registered agent in your home state. If you use another state, however, you don’t have that choice. You will have to hire and pay someone to serve as your registered agent.   

There is usually no benefit with regard to paying taxes either. Generally speaking, you will owe state taxes in the state where you have a physical nexus. Therefore, unless your physical operations are in the lower tax rate state, simply filing in another state garners you no benefit when it comes to the payment of state taxes. If you have a choice on where you would locate your physical operations, then you may want to research what state has favorable tax benefits.

So, why do people incorporate in other states? Let’s look at some of the favorable jurisdictions to see the benefits of filing in another state.

Delaware

You have probably heard more than once that you should incorporate in Delaware. Why is the small state so popular? Primarily, Delaware has built a well-deserved reputation for being business-friendly. They have well-established owner-friendly business laws enforced by judges who hear nothing by business cases. If there is a lawsuit by shareholders, Delaware law gives the owners or the board of directors a lot of flexibility.

Because of this tradition, many large publicly traded companies incorporate in Delaware. As a result, many large investors, such as venture capital firms, prefer to invest in Delaware C corps. The big money investors are simply more familiar and therefore more comfortable investing in Delaware C corps. If you are determined to become the next hot new venture-backed tech start-up, you may want to consider forming a Delaware C corp. Then again, if you have a great business, even if an investor knows nothing about South Dakota, LLCs, they will figure it out or ask you to convert to a Delaware C Corp when they invest.

Delaware also allows for a lot of privacy. In many states, the owners, officers or directors are public records and easily searchable online. For a variety of reasons, you may want to keep the ownership of the company off the internet. Filing in Delaware may allow you to do that.

While Delaware is popular, it is by no means required. Filing in Delaware has some advantages, but if you are opening a small LLC in your home state and do not mind your name in the public record, forming it in Delaware is likely not worth the extra cost and administrative work.

Wyoming

A relative newcomer to the list is Wyoming. With regard to privacy, it equals Delaware. For those wanting to save a little money, Wyoming only charges $100 for the initial filing and $50 for the annual statement. Delaware’s initial filing fees are comparable, but charges $225-$300 for the annual statements. Wyoming has also made it easy and affordable to convert the company you formed in another state to a Wyoming company. It is cheaper to convert to a Wyoming LLC than it is to pay the periodic filing payment in Nevada.

Colorado

Colorado is another jurisdiction with favorable privacy treatment and reasonable filing costs. You do not have to disclose the names of the owners, board members and managers with Colorado entities. Moreover, the filing fees are only $50 to form the entity and the minimal periodic fee is just $10. While this focuses more on filing fees as opposed to tax rates, if you are required to pay corporate state taxes in Colorado, they are only about 4.63% compared to more than 8% in Delaware.

Arkansas

Arkansas makes the list because it, too, provides a lot of privacy for the owners and managers of the business. You are not required to provide the name of the owners at the time of forming your Arkansas entity. You do have to provide it with the filing of your periodic reports, but it does not become a public record. Finally, the initial filing fees are relatively low in Arkansas ranging from $50-$60.

You may have read that Nevada is also a popular option. The state wanted to become the primary alternative to Delaware and it adopted many of the business-friendly laws and rules. We did not include it because Nevada recently increased their fees a substantial amount.  The annual statement fees for an LLC are $350 and $650 for corporations. If every dollar matters, there may be other states to use other than Nevada.

This list is for those who want to form your company in a state other than where you are primarily operating. If you want to consider the best place to actually operate your business, you will need to consider taxation, costs of doing business, access to transportation and labor and a number of other factors. Other sources such as Forbes and the U.S. Chamber of Commerce have put together studies ranking the best places to actually conduct business.

When deciding where and what types of entity to file, a professional such as a financial advisor or lawyer can always help you make the right choice for your specific situation.