A key aspect of starting or growing your own business is incorporating it, which means making it its own distinct legal entity. Once incorporated, your business will be responsible for abiding by the appropriate laws, filing requirements and paying any applicable taxes and fees. These details become especially important when deciding to incorporate a new or existing business in another state.
Because some aspects of incorporation (e.g. tax types, tax amounts, filing frequencies, etc.) vary across state lines, it’s important to know what you’re getting into. Some states offer tax breaks to bring in investment and to persuade businesses to look outside of their first intended location. There are certainly perks to out-of-state incorporation, but there are some drawbacks too.
If your business is more of a mom-and-pop sized storefront or office, and you conduct a substantial portion of your business there, then incorporating your business out-of-state may not be worth your time. Also, due to the proliferation of online-only businesses, some small business owners erroneously believe that they can solely incorporate in the state where they aren’t physically located. If you decide to do this, you may run afoul of tax laws in your home state, and be liable for any unpaid fees and penalties.
But if you want grow a business by selling equity in anticipation of an initial public offering (IPO), then incorporating in a jurisdiction with relaxed corporate ownership restrictions may be advantageous.
Whatever the circumstance, if you think your business could benefit from out-of-state incorporation, keep reading. We’ll review the top states to incorporate in and the steps you should take to do so.
How Do I Incorporate My Business in General?
If you haven’t incorporated your existing business already, then here’s what you need to do:
- Decide which state you want to incorporate in. Visit the Secretary of State’s website and look at all the incorporation requirements, including all of the necessary paperwork. If you incorporate in your state of residence, then you will have what is known as “home state incorporation.” If you decide to incorporate outside of your pre-existing home state, then you will be operating as a “foreign qualified” entity.
- Download and read the state’s articles of incorporation. This is sometimes referred to as the “certificate of incorporation,” “letters patent” or “charter.” You should also print a copy for your records, as you’ll need them for reference to complete your own articles of incorporation.
- Pick your corporation’s name, and make sure it is unique. Some Secretary of State websites allow you to search for incorporated business names online. You cannot incorporate two businesses with the same name in the same state. When choosing your name, don’t forget to add a corporate designator, or an abbreviation thereof, to the end of your corporation’s name (i.e. Incorporated or Inc., Corporation or Corp., Limited or Ltd.).
- Fill out your company’s articles of incorporation, including your company’s name, the organizing members of the organization or board of directors, etc. Click here to download an articles of incorporation template that you can use to set up your corporation.
- File the completed articles of incorporation with the Secretary of State’s office.
- Hold your organization’s first meeting to establish your bylaws, then submit these bylaws to the state. Download a corporate bylaws template by clicking here. You may need to submit them with your articles of incorporation; it depends on the state’s requirements. Check the Secretary of State’s website for details.
Why Would I Want to Incorporate in Another State?
First and foremost, if you plan to physically expand your previously-incorporated business into another state, you should strongly consider incorporating there. Avoiding incorporation can lead to fines and penalties come tax time. This is especially important if you plan to conduct a significant amount of your business in the new state.
As previously mentioned, some states offer a number of incentives to attract business to boost investment, raise tax revenue or simply enhance a state’s profile as “business friendly.” These can include:
- Low or non-existant tax rates. Some states lower or completely eliminate taxes with the belief that doing so will spur economic activity. For the business owner, this could mean higher profits from a higher sales volume relative to a higher-taxed state. This could apply to personal income, capital gain or receipt-based taxes, among others.
- Business-friendly laws and courts. If you do business in a heavily regulated or liability-prone industry, having business-friendly laws could save you from costly lawsuits or onerous legal judgments.
- Easier equity sales and IPO. State laws differ in how they regulate the sale, ownership and taxation of stock. Should you wish to sell parts of your company or seek equity investors, incorporating your business in an equity-friendly state could save you—and your investors—lots of money.
If you ultimately decide to incorporate your business in another state, however, you can’t forget about obligations in your home state.
In most cases, you will likely be held responsible for taxes on your sales, income or any capital gains that you would with home state incorporation. In some cases, you may even have to register as a “foreign” corporation to lawfully conduct business as a separate legal entity in the state. Be aware that being a foreign corporation could hinder some aspects of your business, including opening a business bank account.
Top States for Business Incorporation
You’ve probably heard that Delaware is a great state to for businesses, and it’s true. Currently, half of all the publicly traded companies in the U.S. and over 60% of all Fortune 500 companies are incorporated there. Aside from not charging any sales tax, Delaware has worked hard to make its incorporation services easy to use, including offering legal guidance within their extremely business-focused court system. Additionally, Delaware’s laws are fairly relaxed and offer high limits on the amount of interest lenders can charge borrowers.
This western state is known for its extremely low tax rates and commitment to privacy. It’s also one of only three states to enforce no corporate or individual income tax or tax on any corporate shares. Nevada’s business court system is often touted as one of the best in the country, and the state’s legislation has very relaxed regulations surrounding the issuance of shares.
Businesses can offer shares in exchange for capital, services, personal property, etc., which gives businesses a high level of creativity. On top of that, the state grants a company’s directors the right to control company share value.
Another state that doesn’t levy any individual state income tax and also exempts S corporations from state taxation is Florida. The state’s online business infrastructure is considered by some to be the best in the country, featuring a searchable database of documents and online filings. It’s especially beneficial for software companies to incorporate in Florida, as the state provides tax exemption for business-to-business software sales.
The Tax Foundation ranks South Dakota as the top state for incorporation in the U.S. Aside from not enforcing any income tax, corporate or personal, South Dakota also offers business owners legal protection against their personal income or assets being used to satisfy corporate debts. Its filing burdens are also low, which can be especially important to new companies that may find it difficult to keep up with frequent filing requirements when they are trying to get their business off the ground.
Montana-incorporated businesses are eligible for a high number of tax deductions, many that aren’t available in other states (PDF). Some of these credits and deductions include job credits, research and development deductions and deductibles for the cost of goods sold by the business. Montana also does not charge a gross receipt tax, which can decrease the company’s taxable income amount.
Incorporating your business may not be right for every business, but it’s certainly worth considering. By incorporating yours in the right jurisdiction after some research, you can make it a step that works to your advantage for many years to come.
For more information about different legal entity structures, read our article comparing LLCs to S Corporations.