If you're starting your entrepreneurial journey, you probably already have big ideas about what your business will sell and how you want to run it — maybe you've decided to form an LLC to get your world-changing idea off the ground. One big question remains though: What state should you form your LLC in?
For many businesses, a Limited Liability Company (LLC) is the perfect choice. LLCs are designed to be quick, easy and inexpensive to form. You won’t have to follow many of the more onerous compliance issues that larger businesses have, and you can typically set up an LLC in just a few hours.
At Incfile, we’re experts on every aspect of setting up, creating and managing an LLC. Here’s our handy guide to choosing the perfect state depending on various legal issues, market demand, taxation rates, job markets and more.
The Best State to Start Your LLC: Domestic vs. Foreign LLCs
Before we get into deciding which state is best for your company, it’s important to provide some background. There are two main types of LLC: “domestic LLCs” and “foreign LLCs.” A domestic LLC is a company that only does business in the state where it is formed. For example, a couple of freelance marketers decide to start a marketing business in North Carolina, where they live. They form an LLC with the North Carolina Secretary of State, do all of their work in North Carolina and pay North Carolina state taxes. They are considered a domestic North Carolina LLC.
In contrast, imagine a new organic foods restaurant starts as a domestic LLC in Connecticut. After some initial success, they decide to expand north into Massachusetts. At that point, they have to file as a new foreign LLC with the Secretary of State of Massachusetts. This means they're responsible for obtaining business licenses and paying taxes and other fees for any business conducted there. Nationwide businesses are required to maintain a foreign LLC in 49 states and a domestic LLC in their state of origin.
In most cases, you should form an LLC in the state where you are expecting to conduct most or all of your business. If you’re just conducting business locally or you’re purely an online business, it almost always makes sense to start your LLC in your home state. That’s because you’d need to setup a foreign LLC anyway if you incorporated in Delaware but wanted to do business in North Carolina or Connecticut.
The Best State to Start Your LLC: Legal Reasons
You may have heard that Delaware is a great state to start a business. While that’s true in some cases, Delaware company formation is mostly for larger businesses. What sets Delaware apart is its Chancery Court. This court handles only business matters and rules cases very quickly. While that can be useful for larger corporations with many legal interests, your new LLC probably isn’t going to benefit that much.
If you are planning to expand your LLC nationwide and even want to go public one day, Delaware could be a great choice. Wyoming also have very business-friendly environments with low taxes, incorporation fees and annual fees. Despite this, small LLCs with less grand ambitions are almost certainly better off forming in their owner’s home state. It’s less administrative hassle, and you won’t have to get into the foreign LLC situation until you are ready to expand.
The Best State to Start Your LLC: Series LLCs
A regular LLC isn’t the only choice for starting a limited liability corporation. Certain types of businesses in certain states can take advantage of a business type called the Series LLC.
A series LLC is a specialized type of Limited Liability Company. It functions much like a traditional LLC in many ways with one important exception: You can create unique “series” or “parts” of the LLC. Each series has its own interests, assets, ownership, and operations.
In this case, you can think of the overall LLC as an “umbrella business” with separate businesses underneath it, known as a series. The overall umbrella LLC controls the series of LLCs below it, but these series effectively operate as completely independent companies. This means that each series LLC has separate liability protection, simplified reporting, and other benefits.
Series LLCs are useful for businesses like real estate investors who might have a separate LLC for each property, builder or manufacturer. Series LLCs are only available in certain states, which currently include:
District of Columbia
However, many states still allow series LLCs that are formed in other states to conduct business in their state as well. Other states do allow the creation of Series LLCs, but they may interpret the law slightly differently. These include Minnesota, North Dakota and Wisconsin.
The Best State to Start Your LLC: State and Sales Taxes
If you're like most business owners, you probably want to pay taxes that are as low as possible. LLCs are known as “pass through” entities — any profits they make “flow through” to the members’ and owners’ personal tax returns. That means if you incorporate in a state that has low or no state taxes, you could significantly reduce your tax liability and save yourself thousands of dollars.
There are 41 states that have some kind of state income tax, which leaves several that do not. These are the states that have no state income tax:
New Hampshire and Tennessee do not levy state income tax on wages — only dividend and interest income. Outside of the ones listed above, the states with the lowest state tax rates are:
The states with the highest state taxes are:
Another area to consider is sales tax since it can impact both your cost of living and the cost of goods and services you provide locally. There are 45 states and the District of Columbia that charge sales tax. The following states are where you'll find the highest combined state tax and sales tax rates:
States with the lowest combined state tax and sales tax rate could be ideal for setting up an LLC. These include:
Remember that no matter which state you're in, specific counties and cities may add additional sales tax to the statewide tax rate, so bear that in mind.
The Best State to Start Your LLC: Local Demand for Products and Services
If you only plan to sell online, the state you incorporate in won’t be influenced by your local market. However, if you’re a more traditional business, you should incorporate in a place where there is going to be local demand for your products and services. There are several ways to find the best states for local product and service demand:
Look at the number of competing businesses in the city, county and state where you want to incorporate. More competitors normally mean more demand for that product or service.
Carry out market research into the local market. There are a number of marketresearch firms who can provide locally-targeted reports.
Look at the cost of living in particular cities and states. This can influence demand for products and services and inform how much you and your employees will pay to live there.
Use your instincts and common sense. There’s not going to be much demand for snow-clearing services in South Carolina or beachwear in Arkansas!
The Best State to Start Your LLC: Access to Skilled Employees
If your business provides highly-skilled, professional products or services, you want to ensure you’ll be able to hire the right people. Before you decide where to incorporate, explore the local labor market, look at job boards in your industry or see what programs the state's best universities are offering to study. Access to skilled people is essential to most businesses, so do your local job market research before making the final call.
The Best State to Start Your LLC: Cost of Incorporation, Licenses and Annual Reports
Finally, the cost of creating and running an LLC may play into your decision. Incorporation and annual filing costs vary widely, from below $100 to over $500. You can use Incfile's “Incorporate Now” function to see the costs of incorporating in each state. You can also view our individual state pages to see what the ongoing costs and filing fees will be for your LLC depending on where it's located.
Our overall recommendation is to carry out complete research on the local market you want to serve, look at the various tax implications and ensure you'll have access to skilled employees. In most cases, incorporating in your home state is the right thing to do. Why not go ahead and start today with Incfile?
Paul is a freelance writer, small business owner, and British expat exploring the U.S. When he’s not politely apologizing, he enjoys hats, hockey, Earl Grey Tea, mountains, and dogs.