Things to Consider When Choosing a State for Your LLC
Apr 24, 2023
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A limited liability company (LLC) is a type of US legal structure for businesses. It creates advantages similar to those of a corporation and some benefits of forming a partnership. LLCs are an attractive option for many small businesses because they offer limited liability protection, pass-through taxation, and flexibility in ownership and management. They have a relatively simple setup and maintenance process.Here is an overview of the advantages of an LLC, the purpose of an LLC, and common businesses that are suitable for an LLC. Then, information about where to form an LLC and the benefits of registering an LLC in certain states.
What purpose does an LLC serve?
The purpose of an LLC is to provide a structure that allows individuals to conduct business with limited personal liability. This liability limitation means that the members/owners of the LLC are not responsible for the debts or obligations of the company, with a few exceptions. This structure protects the members from being held personally liable for any debts or obligations of the business.
Another purpose of an LLC is to provide the members with tax advantages. An LLC can choose how the IRS recognizes it for taxes, as a partnership or a corporation. This option allows the owners/members of the LLC to benefit from the pass-through taxation of a partnership combined with the limited liability of a corporation.
The LLC structure also allows for more flexibility regarding ownership and management. An LLC is not required to have a board of directors and can choose its unique management structure.
What kinds of businesses are usually set as limited liability companies?
The common types of businesses that are LLCs include consulting, construction, real estate, technology, manufacturing, retail, e-commerce and professional services, such as doctors, lawyers, accountants, stock brokers, etc. An LLC is a business entity often used for holding investments and owning real estate.
Advantages of an LLC:
The advantages of an LLC include liability protection, avoiding double taxation, and flexibility. They are also relatively easy to set up and maintain.
Liability Protection
As indicated in the name of this type of legal entity, an LLC offers limited liability protection for its owners. The owner's assets are usually not at risk if the LLC faces a lawsuit, incurs debt it cannot pay, or goes bankrupt.
This liability protection is the same as a corporation's; however, the paperwork is easier to manage with an LLC, and the record-keeping requirements are less.
Avoiding Double Taxation
Another key benefit of an LLC is the ability for the owners to choose to have the LLC pass-through profits and losses to the owners. In this case, the LLC only files an information tax return that shows the profits and losses for the previous tax year and the percentage allocated to each owner according to the ownership interest in the LLC for each person. Using an IRS schedule K-1 for reporting each owner's share is the same form used to allocate profits and losses made by a partnership.
With this option, the LLC is considered a disregarded entity by the Internal Revenue Service (IRS) and does not pay any federal tax. The owners of the LLC pay taxes on LLC profits as individuals. This structure may result in significant tax savings for the owners.
Flexibility
LLCs are more flexible than corporations when it comes to ownership and management. LLCs have fewer restrictions on the number of owners who can be LLC members, making it easier to add or remove members as needed. Members own units in the LLC, representing a percentage of ownership in the company.
LLCs also have more flexibility in terms of management, since the owners can decide how to manage the company. Ownership in an LLC is not limited to individuals. It can include other businesses as owners. This structure may make it easier to bring in investment capital and resources.
Easy to Set Up and Maintain
An LLC is relatively easy to set up and maintain. There is less paperwork. An LLC does not have the requirements that a corporation must follow, such as having a board of directors and board meetings. LLCs are not required to hold regular meetings or keep records of them.
Choosing a State: What to Consider?
The state where an LLC files its formation is called the initial "domicile." A business may register in more than one state. The first state is the one that is considered a "domestic" LLC. Every other LLC registration of that first LLC in other states registers it as a "foreign LLC." In this case, foreign means out-of-state but also includes other countries.
When choosing a state for an LLC, the main considerations are location, taxes, regulations, cost, resources, and liability protection.
Location: Physical Locations and Conducting Business Rules
Businesses that maintain physical locations must form an LLC in every state where they have a physical presence. They may also need to register as a foreign LLC in the state(s) where they conduct business but do not maintain a physical presence.
Registering an LLC as a foreign LLC means that the LLC initially registered in one state and is now registering to do business in a different state. This new registration is necessary when an LLC wishes to expand its services, products, or operations in other states. Typically, foreign LLCs must pay a fee to register. They may be required to provide additional documents to the new state to comply with local laws.
California
Conducting business is defined differently by each state. For example, California defines doing business in California as "entering into repeated and successive transactions." This "doing business" can be as simple as holding business meetings in the state or when one person on a call is in the state.
For instance, it is false to believe you can form an LLC in Nevada to save on state taxes and operate a business in California or sell to California residents. If the company is in California, you must either form your LLC in California or register your out-of-state LLC as a foreign LLC operating in California.
If you live in California and conduct all your business in other states, you may want to avoid forming an LLC in California if you can do so legally, due to the high taxes that business owners pay in that state.
Taxes:
Comparing the state taxes for an LLC is an important differentiator. Calculating the potential state income taxes for the LLC, and its owners, is prudent. Suppose the owners decide to use the LLC as a pass-through structure that does not pay federal tax. Even though an LLC can avoid paying federal taxes, it may be subject to state taxes, depending on the state. The owners pay individual federal income tax on their profits and may have to pay state income tax.
Wyoming, South Dakota, and Nevada (maybe)
Wyoming, South Dakota, and Nevada do not have any corporate (including LLCs) or individual income tax. However, Nevada has a gross receipts tax (also called a commerce tax) for any company earning over $4 million annually. The Nevada gross receipts tax rate depends on the type of business. Nevada is very attractive for companies with annual gross receipts under $4 million.
Regulations:
Many companies choose to form an LLC in a state for their headquarters subject to fewer regulations than in other states. If you look at many of the major companies, they are registered in certain states. The most popular ones are Delaware, Nevada, Texas, and Florida.
Delaware and Wyoming
Delaware has the most business-friendly legal environment and offers the most comprehensive and flexible LLC laws. The state with the least regulations for an LLC is Wyoming. Wyoming has no taxes on LLCs, no annual reports to file, no restrictions on foreign ownership, and no restrictions on multi-member LLCs.
Costs:
There are various costs to consider. The first is the cost of filing to form the LLC. Registration of the LLC by filing its articles of organization may be as low as $50 and up to $520 (Massachusetts). The second is the cost of having a resident agent accept service for your company if you do not plan to maintain a physical location within the state that is open during normal business hours. The third cost is the annual renewal fee to keep your LLC in good standing.
Additionally, some states charge a franchise tax fee, which is the minimum payment for state taxes (California's franchise tax fee is $800 yearly even if the business runs at a loss) and a fee for a business license.
Colorado, Michigan, Mississippi, and Missouri
These states have a $50 fee for filing the articles of organization of an LLC. There is another $50 fee to register a resident agent for the LLC. You pay an additional fee for the services of a resident agent. Depending on the business, you may need a business license.
Wyoming, Nevada, and Oregon have low costs also.
Resources:
Focusing only on the advantages of forming an LLC in a state may miss the big picture question: Which states are better for operating a business? Choosing a state for its resources may be the best way to go.
North Carolina
North Carolina is considered one of the best states for businesses because it offers various resources and incentives. Forming your LLC in NC may be smart because the state came in first as the most business-friendly state in 2022.
The state's business-friendly tax code encourages investment, provides access to capital, and fosters entrepreneurship. Additionally, North Carolina offers businesses a wide range of financial incentives and assistance programs, including tax credits and grants. North Carolina has several top-tier universities, research centers, and incubators, which provide access to a talented workforce and cutting-edge research. North Carolina has a strong infrastructure and an ideal climate for businesses to thrive.
Liability Protection:
In general, the LLC structure provides limited liability for its owners to protect their personal assets from being encumbered by business operations, debts, or a lawsuit. However, lenders often ask owners for personal guarantees, negating this debt protection. Moreover, LLC owners' negligence, fraud, or other criminal behavior may create liability for them.
Conclusion: What are the best states to form an LLC?
If you plan to own and operate an LLC in your home state, the best state for forming the LLC is the home state. There is no reason to justify the expense of having an LLC in another state when you are doing business only in your home state.
The best states to form an LLC for multi-state businesses are Delaware, Wyoming, Nevada, and Montana. These states all offer attractive tax benefits and legal protection for LLCs. They also have flexible regulations and allow for single-member LLCs.
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