Incorporating in Delaware or Nevada: Good Idea or Bad Advice?

Obtaining “corporate-status” is an important step for a business and its owners. Successful incorporation (i.e. registering the business as an LLC or Corporation) separates personal and business liabilities, essentially providing a layer of protection (or a corporate veil) between the owners and the businesses they own. 

However, incorporation can complicate your company’s tax situation.  For this reason, owners are in a constant struggle to maximize revenue, while minimizing their tax burden and maintaining their protective corporate veil.  To this end, many savvy owners look-to more “business-friendly” states to register their LLCs or Corporations.  

Some states levy substantial taxes and other regulations on the entities incorporated in their state.  For example, New Jersey has among the least business-friendly laws in the nation, charging high corporate tax rates (as much as 9.00%) in-conjunction with high property, sales, and individual taxes.   If you owned a corporation in New Jersey, wouldn’t it make sense to move operations to a more business-friendly neighboring state?  

This is called “Incorporating Out-of-State”, and while it may be a worthwhile consideration, it’s not as simple as it sounds.  In the U.S., Delaware and Nevada have both garnered a business-friendly reputation by offering a favorable regulatory environment for incorporated business and their owners.  

In-fact, the majority of Fortune 500 companies are registered in one of these two states (especially Delaware). A coincidence?  Certainly not, but incorporating out-of-state isn’t realistic for every business.  Let’s take a closer look at these two states.

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Incorporating in Delaware

The Delaware legislator has a corporate-friendly reputation that goes back to the 18th Century.  In-fact, the pro-business environment in Delaware predates Nevada’s by quite a bit, and some opine that the recent business-centric regulations in Nevada are merely an imitation of the Delawarean policies, such as:

• No State Corporate Income Tax
• Non-Residents aren’t Required to Pay Personal Income Tax
• Stock Shares aren’t Taxed or Charged Fees
• Tolerant Tax Regulations for Companies with Large, Complex Ownership Structures
• Tolerant Tax Regulations for Companies with a Large Number of Shares

The regulations in Delaware are largely predicated on rolling-back corporate taxes and increasing flexibility, especially for big businesses.  This is precisely why investment bankers often require Fortune 500 companies to register in Delaware; publicly traded companies (those with hundreds of owners and large numbers of shares) can more easily operate under Delaware’s pro-investor legal framework, especially when it comes to securities laws.

Also worth noting is Delaware’s Court of Chancery.  Established in 1792, this unique legal body is a high-ranking business-focused court with incredible legislative power.  Decisions of the court are made exclusively by judges (as juries aren’t involved), which ensures faster and more predictable resolutions for businesses.  

Incorporating in Nevada

The emergence of Nevada as a pro-corporate state is a relatively recent phenomenon.  Nonetheless, big-businesses (especially those from neighboring California) are increasingly turning to Nevada to incorporate and gain access to the state’s corporate-friendly benefits, like:

• No State Corporate Income Tax
• Non-Residents aren’t Required to Pay Personal Income Tax
• Stock Shares aren’t Taxed or Charged Fees
• No Franchise Tax is Required for New Businesses
• Non-Residents are Permitted to Hold High-Ranking Roles (Shareholders, Officers, Directors)
• No Minimum Capital Requirement to Incorporate

There’s some obvious overlap between the two states.  One thing worth noting is that Nevada business aren’t required to pay a franchise tax, while this is an obligatory fee in Delaware.  Also similar to Delaware, investment bankers often require publicly-traded companies to register in Nevada, in an attempt to bypass some of the more stringent Securities-related regulations.

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Think Twice about Incorporating Out-of-State

To incorporate in one of these states, a local address is required.  This means that in addition to paying state taxes and filing fees, you will also need to have an office address in that state or pay for a registered agent (a service where a company located in the state lets you use their address and will forward you the official correspondence you receive).  Additionally, the Delaware and Nevada legislators charge relatively high filing fees and administrative costs for incorporating in their state.  This results in substantial (and often-times overlooked) upfront expenditures.

For these reasons, most attorneys advise small to mid-sized businesses incorporate in the state in which they reside.  The administrative costs and registered agent expenses associated with incorporating in Delaware or Nevada often outweigh the benefits of the states’ pro-business policies for smaller businesses.

However, for incredibly large multi-national businesses, these upfront costs are quickly repaid by tax-savings or legitimacy from institutional investors.  For instance, Fortune 500 companies like Apple (initially incorporated in California, re-incorporated in Nevada in 2004) or Boeing (initially incorporated in Washington, re-incorporated in Delaware in 1934) generate millions of dollars of revenue annually, so the fees associated with out-of-state incorporation are quickly replenished by the tax savings and other investments.  

Generally, incorporating out-of-state is only worthwhile if: 1) the business is large, with may shares and many owners/shareholders, or 2) the owner plans to operate primarily in that state.  Otherwise, out-of-state incorporation is not an effective strategy for reducing your tax-burden, and can in-fact compromise the protections associated with your corporate-status.