Many business owners ask if it’s a good idea to open an LLC in Delaware even if they don’t live in the state. While Delaware has a reputation for being a great U.S. state for doing business, forming your LLC in a state other than your home state isn’t recommended.
What is an LLC?
An LLC is a business entity in which the owner’s (called a member) personal assets are, generally, not available to pay business debts. Unlike a sole proprietorship, another popular type of business for one person, an LLC takes on all liability of the business and requires you to file formation documents with the state to exist.
If you’re a new business owner and are confused about which business entity to choose, don’t mix these two up with a corporation (or C corporation), which also takes all business liability but is owned by shareholders, pays dividends, and is legally considered an individual with separate income tax.
The tax treatment of LLCs is one of their biggest benefits, as LLC income is not subject to corporate taxes. Instead, the individual owners or members of the LLC pay personal income taxes on profits. This allows LLCs to avoid double taxation in most states and lowers your LLC’s tax rate.
Myths vs. Facts About Forming an LLC in Delaware
Many entrepreneurs want to find the best state to register their company in. Delaware is a popular option for a few key reasons. However, most of those reasons don’t apply to small businesses.
- Business-friendly laws: Delaware’s General Corporation Law and the Limited Liability Company Act offer many benefits and protections to business owners. While this is useful for larger corporations, most solopreneurs won’t need to deal with courts often enough for this to matter.
- Tax benefits: Delaware levies an 8.7% corporate income tax as well as imposing a gross receipts tax. LLCs formed or registered in Delaware are also required to pay an annual tax of $300. The state doesn’t impose a property tax, so you can own an office in Delaware just by paying county-level real estate tax. While Delaware’s taxes may be less than your home state’s, you’ll still pay taxes in your home state, so there may not be significant tax savings for your business.
- Privacy: The state doesn’t require you to publicly put the names and addresses of members or managers in public records, letting you maintain privacy. All you need is a few pieces of information and a name for your LLC.
- Series LLCs: Delaware is one of the states that allow for series LLCs, effectively letting one LLC have multiple separate sub-entities within it. However, series LLCs are complex and not recognized in every state. You’ll likely need legal help with series LLCs, which is expensive. Also, even if a series LLC is right for you, your state might not recognize it.
- Investors may prefer Delaware companies: If you hope to one day grow your company through investment or venture capital, many investors prefer businesses incorporated in the state. But, if you’re running a small company that isn’t treated as a C corporation and never plans to raise money, you won’t need to form your business in a state that’s attractive to investors.
- Costs: Startup costs can be included under qualifying expenses when writing off expenses in your first year.
Filing a Certificate of Formation
The Delaware Secretary of State only requires you to provide the following information for your articles of organization: your LLC name, your registered agent’s name and address, the name and signature of the person authorized to form the LLC, and a cover page.
You’ll need to register your business name with the Delaware Division of Corporations. Unless you’re a single-member LLC, you’re also required to draft an LLC operating agreement. After that, you can obtain your Federal Tax ID (employer identification number) from the IRS and open a new business bank account.
The Delaware Court of Chancery
This is a unique feature of forming a Delaware LLC. Delaware has its own special court system called the Court of Chancery, which Delaware-based companies use to address legal disputes expediently. Judges in this court specialize in corporate law, making this a good option for any company expecting regular litigation action, like companies that defend intellectual property.
Why You Shouldn’t Form an LLC in Delaware
Given the benefits of forming an LLC in Delaware, you might wonder why using the state to register your business is a bad idea. If you live in Delaware, you’ll want to register in the state. However, if you live elsewhere, there are many drawbacks.
Added Complexity
Registering your LLC in Delaware doesn’t give you a get-out-of-jail-free card when it comes to following federal regulations or your own state’s rules regarding LLCs. If anything, it just makes your life more complicated.
Your company will need to comply with the filing and licensing requirements of your home state in addition to the requirements established by Delaware. This means that you do twice as much paperwork to file annual reports and the like.
Even worse, if your company winds up in a legal dispute, you’ll have to resolve that dispute through Delaware’s court systems. That means traveling to the state for every court date and hiring a lawyer in Delaware.
Higher Costs
In addition to the costs related to filing in multiple states and dealing with multiple states’ regulatory environments, you’ll have to pay to register your Delaware LLC. The state has higher filing fees than many other states, and you may have to pay additional state taxes and annual fees.
You also need to use a local registered agent to remain in good standing with the state of Delaware. This likely means hiring an individual or business entity in the state, which is an additional expense. If you don’t want to use an LLC formation service, you or one of your members can be a registered agent or hire a registered agent service.
No Real Tax Savings
Just because you’re incorporated in a different state doesn’t mean you can skip paying taxes in the state where you actually operate.
Your home state will expect your LLC to pay any relevant sales tax, excise, income and franchise taxes. Ultimately, that means you could pay more taxes by incorporating in Delaware rather than your home state. For example, you’ll pay both your home state’s taxes and applicable Delaware taxes.
Paying taxes in two states will likely offset any savings you’d get from forming your LLC in Delaware.
Complex Business Structures
Forming a series LLC in Delaware might sound appealing, especially if you have multiple lines of business that you want to keep separate without opening multiple LLCs.
However, series LLCs are relatively unique and aren’t offered in many states. They’re also new, so there isn’t much precedent or case law related to them and how they work.
If you opt to form a company in Delaware so you can take advantage of the option to create a series LLC, future legal precedents may eliminate some of the benefits you were hoping to receive.
Foreign Qualification for Your LLC
If you form your LLC outside of your home state, you’ll likely need to go through a process to register your company as a foreign LLC that intends to operate in your state. Failing to do so can result in fines and other penalties.
This adds additional complexities to running your business and may create more costs. For example, filing for a foreign qualified LLC in Massachusetts costs $500. If you fail to register, you’ll be fined that amount.
Final Word
Ultimately, unless you live and do business in Delaware, forming your LLC in the state isn’t worth the effort, expense, or hassle. If anything, it’s a business mistake that can cost you money rather than help you save money since you’ll have to pay additional state filing fees and hire more people.
Incorporating in Delaware primarily benefits large corporations that are likely to take advantage of the state’s friendly courts and other benefits. For small business owners, it’s usually best to register your LLC in the state where you live to keep things simple and save money.
