By Christine Chu

If you’re trying to incorporate your business, you already know that creating a separate business entity is a smart way to reduce your individual liability. You may have chosen to incorporate as an S-corp, C-corp, or an LLC, depending on what kind of structure best fits your organization.

Finding the best state for your business to incorporate in, however, is a separate issue. Each state comes with its own laws regarding requirements, fees, and tax responsibilities for businesses. Let’s dive into some ground rules for choosing a location and where the best states to incorporate are.

Ground Rules

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The state you choose to incorporate in is up to you; you’re not bound to the state you live or work in. In the case of businesses that only do business in their home states, yes, it does make sense to register in that specific state. For online businesses, however (like SaaS companies,) it may be best to incorporate in a different state.

Incorporating your business means creating a separate business entity from you or your partners. There are fees associated with incorporating outside of your home state, but you can mix and match the other factors in your favor. The following sections will walk you through formation fees, annual filing fees, taxes, and legal systems, which will help you on the road to incorporation.

Formation fees

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• Best States for Formation Fees: Arkansas, Colorado, Hawaii, Iowa, Mississippi
• Worst States for Formation Fees: Connecticut, Texas, Massachusetts

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Formation fees are the first costs associated with incorporating your business. These are one-time fees paid to the state when you apply for incorporation there. Check out Secretary of State websites for different states’ fees and the most current requirements. Keep in mind these are in addition to fees your facilitator or lawyer might charge to prepare and file your paperwork.

If your budget is generous, the cost of formation may be a minor factor in which state you choose to incorporate in. On the other hand, when you’re trying to keep start-up costs low, the formation fee may be a bigger deal. Unlike filing fees, for example, this a one-time cost; it has less of a long-term impact on your bottom line.

There is a high range of formation fees, starting from just $50 in Arkansas, Colorado, Hawaii, Iowa, and Mississippi. The highest fees are in Massachusetts at $295, Texas at $310, and Connecticut at $455.

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Annual Filing Fees

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• Best States for Annual Filing Fees: Ohio, New Mexico 
• Worst States for Annual Filing Fees: Nevada, District of Columbia, Maryland, Massachusetts

Besides initial formation fees, you’ll be required to file a yearly one-page report with a filing fee, which also depends on the state (note: some states only require biennial reports.) This document keeps the state informed on any changes in your business; the principal address, authorized signatories, and number of stocks issued by the business.

Currently, the best states for annual report filing fees are Ohio and New Mexico; they actually don’t require regular filings. This means that over time, you would save on filing fees and the extra work it takes to file. For perspective: Massachusetts has the highest annual filing fee at $500. Nevada has the second highest annual filing fee at $350; the District of Columbia has a biennial $300 fee. Maryland’s fee is also on the higher end (starting at $300), but it's based on business income (rather than employing a flat rate.)

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Taxes

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• Best States For Corporate Taxes: Nevada, Wyoming, South Dakota
• Worst States for Corporate Taxes: District of Columbia, New Jersey, California, Minnesota, Rhode Island

Taxes play a big part in determining the best states to incorporate in. The less you pay in taxes, the more you’re able to put into running your business. There are three types of taxes to consider here: state income taxes, corporation taxes, and franchise taxes. 

State income taxes mostly affect S-corp businesses; their taxes are based on their distributive share of ownership (through personal income taxes.) C-corp businesses are levied corporation taxes. LLCs can be affected by either type of taxes. Lastly, franchise taxes - also referred to as privilege taxes - are levied for the right of existing and operating within a state.

Franchise taxes are separate from income taxes. Franchise taxes are calculated by the business’ net worth, gross receipts, or even margins; not the money earned by the business. These factors depend on the state, but most states still set a minimum tax owed (regardless of how they calculate franchise taxes.). As such, your business could be losing a lot of money--but still owe a substantial franchise tax. 

The states with the best tax laws are Nevada, Wyoming, and South Dakota, which have no state income tax or corporate taxes. Keep in mind, however, that this only applies to businesses operating within those states. Even if you are incorporated in Nevada, for example, your business operations in another state will still be taxed by that state’s tax laws. The District of Columbia has some of the highest personal and corporate income taxes in the country, with New Jersey, California, Minnesota, and Rhode Island trailing behind.

Legal System

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• Best Legal System for Corporations: Delaware, Nevada, Wyoming
• Worst Legal System for Corporations: Mississippi, New Mexico

A state’s corporate laws are also a big factor in deciding the best state to incorporate in. Delaware has become a popular state to incorporate in because of its favorable business laws. A unique feature is the Court of Chancery, which hears corporate case laws. The Court deals solely with business manners and judges are well-versed in complex business law and procedures. These factors expedite the hearing process and insure corporate cases are handled more efficiently. The resulting legal costs can be much lower in Delaware as compared to states with less business-friendly laws.

States like Delaware where business laws are predictable tend to be lower risk for investors as well, many of whom will insist on a business’s incorporation in Delaware before cutting you a check. According to the Delaware Division of Corporations, it is home to 66 percent of America’s Fortune 500 companies. 

Nevada and Wyoming are among other states well-known for their legal benefits to corporations; Mississippi and New Mexico rank in the opposite direction, according to a 2017 CNBC ranking for worst states for businesses.

The Bottom Line

When deciding what state to incorporate in, fees, taxes, and legal systems are all factors that may help or hinder your business in the long run. Ultimately, the best states to incorporate depend on what factors you prioritize. If you’re most concerned about the potential costs from annual filing obligations, then you’d prioritize annual reports and filing fees. Or maybe you’re forming an S-corp, in which personal income taxes would make a substantial difference in your annual expenses. If you’re considering your legal options (or are in talks with investors,) the legal structure would be your most important factor to consider.

Either way, do your homework on your options as you consider incorporation. Check the state’s individual Secretary of State website for the most direct information on your current rights and responsibilities. You will also find answers to frequently asked questions and contact information if you have more in depth questions. Finally, it’s always smart to get advice from a legal representative who can provide you with experienced, professional guidance for your business.

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