Business creation is at an all time high: between 2019-2020, over 1 million new establishments opened in the US. This rise accompanied the fallout of the COVID-19 pandemic, in which people realized the value of feasibility of working from home. One of the initial steps of forming a business as an LLC involves selecting a state - an important decision.
All over the internet, a number of states have received immense praise as ‘magical’ states for starting up a business. Whilst true for a minority of people, most will soon realize that it is more disadvantageous for them to start their LLCs in these ‘business friendly’ states. Furthermore, for the vast majority of cases, it is far more beneficial to start their LLC at home. This article will explore the reasons for this.
Domestic and Foreign LLCs
One of the most common justifications for people deciding to form their LLC in a ‘foreign’ state like Wyoming, Nevada or Delaware is that they will be able to take advantage of these states’ business-friendly taxation models. However, this is unfortunately not the case, and ignores some glaring statutes regarding how taxation for such businesses should occur.
Put briefly, if your business is a ‘foreign LLC’ (i.e. it does not operate in the state in which it was formed) in one of these ‘business friendly’ states, it is liable to pay taxes in its ‘home state’ where it operates as this is where it is generating income. A general rule to help figure this out is that “taxes will be paid where you earn money”.
Furthermore, if you set up an LLC in Delaware (but live in another state), your LLC must be registered in both Delaware and your home state so that it is able to operate in both. Ironically, this can result in your LLCs being exposed to greater startup costs and tax.
The LLC will have to pay taxes in its home state, yet is also required to pay two sets of: state filing fees and annual report fees. Sometimes, the LLC might be required to pay taxes in both states, which is evidently the worst case scenario.
Home and ‘Business Friendly’ States
In most cases, opting to set up your business in the state in which you love is the most beneficial, and least expensive option. Not only is the process much easier, it is also the better long term option for your business.
Most of the time, a new LLC will be run in the state in which the owner resides, which consequently means that the company is operating and making business transactions within that state too.
There are situations in which the owner of a business can reside in one state, but also own premises with employees in another (i.e. having a production factory in Arkansaw, but living in Kansas), the advice remains the same as the business is most likely still transacting (i.e. making money) in Kansas if this is where it’s being run from.
A final mental exercise that is worthwhile in helping to elucidate which state is your business’s ‘home state’ is undergoing a state tax audit by the IRS. Which state would a court decide your business is based in after considering which one you are in most of the time and where most of your business connections lie.
Final Statement
While the general rule of forming an LLC in your home state prevails in most cases, there are several exceptions to this rule. One of these is when the LLC owner is a non-US citizen/resident. In these cases, depending on whether the business has a physical presence and/or employees in the US or not will determine whether it can choose any state it wants or not.
Furthermore, such businesses without any employees, offices or other buildings of any kind are free to select any state to form their LLC (including the so-called ‘business friendly’ ones). This state will then become where the business will be operated. In these cases, it is then worth considering which is the best state to form an LLC in.
Contrastingly, where such businesses do have a physical presence, their same advice will be applicable here as to the majority. For more information on this topic, please see the attached article by LLC University, which covers it more comprehensively.