Facebook, a company synonymous with Silicon Valley’s cluster of tech-firm headquarters and its origins in Cambridge, is not incorporated in California nor in Massachusetts. Instead, it was incorporated on July 29, 2004, in the State of Delaware.1 Google, despite its Menlo Park roots, is registered as a limited liability company (LLC) in Delaware as well. The list of companies registered in other states, particularly business-friendly ones like Delaware, is endless.
Can a business owner register an LLC in another state? Absolutely. But, whether or not they should do so can vary. This article explores the answer to the headline’s question and underscores the benefits of forming an LLC in a state foreign to one’s own while weighing the potential logistical and financial restrictions it would cause small-scale operations.
Table of Contents
- What is an LLC?
- In What State Should I Register my LLC?
- Benefits of Forming an LLC in a Foreign State
- The Bottom Line
A limited liability company (LLC) is a legal entity formed in order to own and operate a business. Arguably the most straightforward business entity to form, LLCs are largely utilized by owners wishing to protect their personal liability and take advantage of pass-through or “flow-through” taxation, which involves the business’s profits and losses being taxed at the owner’s personal tax rates.2 LLC entities also allow for a simpler organizational structure.
As opposed to corporations, LLCs are not required to have officers or boards consisting of a director and trustees. LLCs instead have “members” and are governed in accordance with their operating agreement, which determines the company’s ownership, management, and each member’s rights and obligations. LLCs are not exclusive to single-member ownership, however. In fact, most states do not restrict ownership. Members include but are not limited to individuals, corporations, other LLCs, and foreign entities.3
(Read: How to Make an LLC)
As noted, a business owner can register their company under any U.S. state. Normally, massive businesses look for states with lenient tax codes and developed corporate law to register their entity. In 2019, 67.8% of all Fortune 500 companies were registered in Delaware alone, almost a quarter of which filed as LLCs.4 As impressive as that figure is, however, the majority of small-business owners will likely benefit from registering their LLC in the state where they operate.
22.3 million out of 30.7 million small businesses are sole proprietors without employees, and a grand portion of those companies are operated through a single-member LLC structure.5 That’s because the LLC’s legal structure is accessible and simple to establish for operations such as mom-and-pop retailers who run their business locally. Operations like these are unlikely to gain any tax benefits or asset protection due to two crucial factors:
(1) Forming an LLC in another state will run the risk of causing a duplicate taxation problem in which the owner is subject to pay business income tax in both states. If a business is operating solely from a fixed location in a particular state, filing paperwork in a different state will not strictly bar them from having to register in the home state as well. Therefore, they may wind up paying business taxes, or at the very least administrative fees, for both states6;
(2) Smaller-scale firms simply do not conduct enough business in other states to merit the high costs and hassle of setting up in a foreign state as a foreign LLC, a process that involves hiring a registered agent to represent the business in said state.
In short, small businesses are better off registering in their home state for logistical, practical, and often financial reasons. And, of course, local operations are inclined to represent the area and communities in which they conduct business.
Now, that is not to say the benefits of forming an LLC in another state is solely reserved for colossal companies — the likes of Facebook and Google — as the following section highlights.
There are numerous reasons why Delaware has been dubbed the de facto “incorporation capital of America”.7 By examining what constitutes its business-friendly climate, the benefits of forming an LLC in any of the favorable states (Nevada, South Dakota, Wyoming, Oregon, among several others) can be understood. Let’s take a look:
- A flexible legal framework that serves business protection. One of the primary distinctions between Delaware and other states less favored for foreign entity formation is the Delaware General Corporation Law, which grants extensive protections to businesses in regards to tax policies and liability defense. Several states have adopted related protections through the legislative process to attract big firms seeking such perks.
- It’s legal. It is no surprise business-enabling states embed their philosophy into tangible laws. After all, while aiming to circumvent certain liabilities, companies do not wish to partake in any unlawful practices. Setting up an LLC in states favoring business and the legal entities on which they are built is 100% legal under state and federal law. If a business stands to gain an advantage through formation in another state, the owner(s) can rest assured the process is indeed legitimate.
- Tax havens. The New York Times first reported about a so-called “Delaware loophole” in 2012, stating companies were shifting royalties and similar revenues from their home-state operations to holding companies — companies, usually LLCs, designed to hold shares of parent entities — in Delaware, where they are not taxed, a tactic resulting in $9.5 billion in tax savings for the corporations.8 Since then, more and more states have co-opted similar functions by following suit. Why? Business incorporation fees typically account for a state’s second-largest revenue source behind income tax, thus incentivizing business formation and support.9
- Specialized courts and history of cases. The sheer amount of companies flocking to Delaware is in large part due to their Court of Chancery. The court handles matters pertaining to legal disputes arising from lawsuits and injunctions instead of damages.7 This specialty results in expedited resolutions to cases involving LLC owners, whereas other states’ civil courts backlog corporate cases. Since the state processes more trials due to the vast number of companies, the body of case law is expansive and serves as a reference for owners and their lawyers. A company in an industry with constant litigation can make the most of such legal proceedings; therefore, it would be logical for its owners to consider forming their LLC in Delaware or similar states.
So, can you form an LLC in another state? Yes, but a better question to ask is: Would your business benefit from doing so? Small business owners, as seen, would not stand to gain much from avoidance of tax liabilities, whereas large companies are prone to find such factors more appealing. In the worst-case scenario, a regular small business owner can experience unforeseen tax implications or, at the very least, create an administrative headache and face the costs of dissolution.
A helpful rule-of-thumb to follow goes, if your company has fewer than five shareholders, it is recommended to form the LLC in the home state.10 That being said, business owners — from sole proprietors to those employing hundreds of workers — should weigh their options to come across a decision that makes sense for the company. And, of course, consult an attorney in order to anticipate any legal risks involved in foreign entity formation.