LLCs, or Limited Liability Companies, are widely considered to be the most flexible legal structure for small business owners to choose from. Not only does an LLC provide personal liability protections and multiple options for reporting to the IRS, but it also offers a low administrative burden. Simply put, LLC owners have a lot of control over how their company is established, including the option to establish their LLC in a state of their choosing.
This leads to lots of debates over which state is the best for setting up an LLC. For example, some might say that Nevada is superior, as it has no corporate income tax. Others maintain that Wyoming is the most affordable option. Still others espouse the business-friendly environment of Delaware. Meanwhile, very few entrepreneurs champion starting an LLC in California, where the business climate is perceived to be less favorable.
But here’s the reality: When it comes to starting an LLC, you’ll almost always want to set up shop in your home state. This is true even if your company is primarily an online business. While a state like Delaware or Nevada may offer real advantages, these advantages are outweighed by the significant disadvantages of venturing beyond the state where you reside
Here’s a full explanation.
Domestic and Foreign LLCs: What’s the Difference?
Any time you form an LLC in the state where you live, it’s legally considered to be a Domestic LLC. By contrast, when you register your LLC in any other state, you’re required to classify it as a Foreign LLC. What’s more, when you have a Foreign LLC, you have to register it in the state of your residence.
For example, let’s say you live in Colorado but register your LLC in Nevada. You will also need to register it as a Foreign LLC with the State of Colorado.
Here’s what that means in practice:
- You have not one but two LLC filings… one in Nevada and one in your home state of Colorado.
- You now have to pay not one but two LLC filing fees.
- You have to pay fees for a Registered Agent in order to use their Nevada address, allowing you to receive legal or tax documents from the state government.
- You also have to pay double the annual reporting fees.
In short, choosing to establish an LLC outside of your home state typically results in doubled costs and doubled hassle. And that can very easily override any financial benefits you might get from, say, choosing Nevada’s tax rate over Colorado’s.
Foreign LLC Fines and Penalties
Basically, every state government has rules in place, dictating that out-of-state businesses register as Foreign LLCs before they can do business within state lines. These rules tend to be rigorously enforced, which means a failure to properly register your Foreign LLC may result in financial penalties, extensive legal fees, or even a suspension of your rights to conduct business.
And just how extensive are the financial penalties for not properly registering a Foreign LLC? It varies from one state to the next, but in some places, it can be thousands of dollars annually. Again, this hefty cost far outweighs any benefits you might receive from “shopping around” for the best state to launch your LLC.
What About Taxes?
A note to entrepreneurs who are starting a business: It’s sometimes assumed that you can start an LLC in a different state so as to take advantage of that state’s income tax rate.
This is erroneous thinking. The rule of thumb is that taxes are paid where money is made. So, to return to our example from above, even if you register your LLC in Nevada, you’d still pay the Colorado tax rate, assuming that’s where you’re doing business and generating a profit.
In fact, you may find that you’re on the hook for taxes and fees in your home state and in the state where you set up your LLC, further eroding any perceived benefit to having a Foreign LLC.
Exceptions to the Rule
Generally speaking, it’s wise to ignore any talk of one state being especially advantageous for establishing an LLC, whether that’s Nevada, Delaware, Wyoming, or wherever else. Having said that, there are a few instances where it actually does make sense to look beyond your home state.
Non-Citizens or Non-Residents
You don’t have to be a citizen or a resident of the United States to start an LLC here. That raises the question: Where do you register your business if you don’t actually have a home state?
Think about how your business will be run. If you’re going to have a corporate headquarters staffed with employees, you should set up your LLC in whichever state your operation is physically located.
If you’re not going to have any physical presence, that’s when you actually do have some leeway to shop around for one of those “magic” states like Delaware or Wyoming.
Real Estate LLCs
Another potential exception is the real estate investment LLC.
If you’re investing in real estate in your home state, then by all means register as a Domestic LLC.
If you’re investing in real estate somewhere else, though, then it’s typically best to register your LLC in whichever state you’re buying properties. If you’re making money in a particular state, such as through rental income, then that’s the state where you’ll want your LLC to be established.
What if You Do Get to Choose the State for Your LLC?
If you are in a position where you don’t have a home state and really do get to choose from anywhere in the country, there are a few specific criteria you might use to evaluate which state is best. Specifically, you might consider taxes, annual fees, privacy and reporting laws, and more.
All else being equal, the best states for starting an LLC are generally considered to be Delaware, Nevada, and Wyoming. All three states have favorable tax environments, business-friendly accommodations, and relatively lax reporting requirements.
But again, if you are already based in another state, it’s seldom worth it to register in one of these states. You’ll still need to register as a foreign LLC in your home state, which means doubling your fees and other administrative requirements. In other words, if you can stick to a domestic LLC, it’s almost always advantageous to do so.
The Bottom Line: It Pays to Keep Your LLC Close to Home
With these few noted exceptions, it’s generally best practice to register your LLC in the state where you live, work, and make money. In some situations, this might mean you’re paying higher fees than you would if you lived somewhere else, but it still beats having two LLC filings to deal with.
If you do have the luxury of shopping around for the best state to launch an LLC, the most popular options are Delaware, Nevada, and Wyoming. But if you don’t happen to live in those states, don’t sweat it: You can still find plenty of success running your own LLC, wherever it might be. Just take a few minutes to explore the LLC guidelines in your current state, and with additional questions, talk with a business attorney or coach.
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