Delaware has long been known as an advantageous place to start a business. But if you live in California, is it really worth it to form your LLC in another state? If you’re considering forming an LLC in either Delaware or California, you should learn more about why so many companies choose Delaware as the official home for their businesses. Let's dive into the pros and cons of starting an LLC in both states.
Delaware vs. California LLCs
If you are trying to decide between forming an LLC in California vs. Delaware, keep in mind that each state has some unique advantages. The advantages of one state might be more or less relevant to your business, depending on your situation.
According to the Delaware Division of Corporations, more than 1 million business entities have been formed in “The First State,” and more than 66 percent of Fortune 500 companies are incorporated in Delaware.
But why? What are the advantages of a Delaware LLC compared to other states, and how can this help your business? Even if you’re not located in Delaware, should you consider forming an LLC in that state?
There are a few historic and legal reasons why Delaware is such a hub of activity for incorporating businesses. Delaware’s state laws are uniquely flexible and advanced for incorporating and forming businesses, and the Delaware Court of Chancery has been in operation for 220 years, writing most of the United States’ modern corporation case law.
If you want to start a corporation or form an LLC, Delaware offers a fast, efficient process and their state laws might be uniquely helpful for your business’s goals. For one, Delaware’s corporation law is known for providing predictability and flexibility for company managers, while also providing protection for investors.
Delaware also offers some tax advantages and flexibility for investors and shareholders. For example, companies that are formed in Delaware, but that do not actually conduct business in the state, do not have to pay Delaware state corporate income tax. Venture capital investors might prefer to invest in companies that are incorporated in Delaware because the state tends to have a good legal system for protecting and balancing the interests of investors and company managers. The fact that so many of the Fortune 500 companies (many of which are publicly traded) are based in Delaware is another sign that Delaware’s advantages are often most useful for bigger companies. While Delaware does charge a franchise tax, it is a flat fee for LLCs. Many other states base this on earned income, so your franchise tax in Delaware could be significantly less than in other states.
Annual franchise tax for Delaware LLC (domestic or foreign): $300
If you are doing business in California, are a resident of California or have your business headquarters in California (even if you also do business in other states), you might want to form a California LLC.
California is not known for being a low-tax state; California LLCs have to pay an annual registration fee of $70 and a California franchise tax of $800 minimum per year.
However, if you want to do business in California, there are advantages to having a California LLC. California is home to some of the biggest industries in the U.S., such as Silicon Valley technology companies, venture capital investors and the Hollywood entertainment business. If you are already located in the Golden State and you want to do business in California, it may be simpler and less expensive to incorporate there.
If you form an LLC in another state, and you want to do business in California with that LLC, you will need to file Form LLC-5 and register as a "foreign" (out-of-state) LLC in California. There are additional fees required for this, as well as whatever fees you have to pay for the state where your LLC is headquartered.
Annual franchise tax for California LLC: $800, plus additional LLC fee for income over $250,000 per year
Is a Delaware LLC the Right Choice for Everyone?
Many of the advantages of incorporating in Delaware are most relevant to owners of a C Corporation since that is the type of company that can be publicly traded and issue different varieties of stock to shareholders. If you are a small business owner or sole proprietor who is considering starting a business by forming an LLC, and you do not already reside and do business in Delaware, forming a Delaware LLC might not really help you.
For example, if you live in California and want to start a business in California, and are trying to decide between a Delaware vs. California LLC, don’t assume that you can avoid taxes or get away with less regulatory compliance just because you set up your business in Delaware. Just forming a business entity in Delaware is not a “get out of taxes and compliance free” card.
There are no shortcuts in business, and while Delaware is a great place to start a business for publicly traded companies or fast-growing, venture-backed startups, that doesn’t mean that all of Delaware’s unique laws and requirements are equally relevant to small businesses. If you’re not issuing stock, if you’re not bringing investors into your company and if you don’t intend to ever go public with an IPO, then the advantages of incorporating in Delaware probably won’t apply to your situation.
Does a Delaware LLC Have to Pay California Taxes?
When it comes to state taxes, both California and Delaware impose a franchise tax, which is a tax for being able to do business in the state.
But what if you are not actually “doing business” in Delaware, but just want to incorporate there for the legal benefits? If your business is located in California, but you choose to incorporate in Delaware, you will need to follow reporting requirements and pay franchise taxes and relevant fees in both states. California LLCs have to pay an annual tax of $800, plus an additional LLC fee for LLC income over $250,000 per year. The Delaware franchise tax is $300.
If you choose to incorporate and only do business in Delaware, but are a resident in California, you still need to pay franchise taxes in both states. California may consider you to still be "doing business" in the state if you are simply directing or managing your Delaware LLC from the state of California.
Keep in mind some additional costs if you form an LLC outside of Delaware and want to do business in Delaware. You will have to submit a Foreign Qualification form in Delaware to be able to qualify to do business in that state, and you will need to pay for a Registered Agent within the state.
As you can see, forming a business in Delaware is not a magical shortcut. There are lots of good reasons to start a business in Delaware even if your business is located in other states. But because of the various fees and reporting requirements involved with incorporating and doing business across state lines, it might not be worth the effort if you own a small business and you don’t intend to bring on investors, issue stock or grow big enough to go public someday.
If you’re a small business owner, and you don’t actually do business in Delaware, forming an LLC in your actual home state may be the best route to take. As the Delaware Corporate Law website explains: “For many small business entities, formation in the state where the corporation will do most of its business may be more cost-effective.”
Ben Gran is a freelance writer from Des Moines, Iowa. Ben has written for Fortune 500 companies, the Governor of Iowa (who now serves as U.S. Secretary of Agriculture), the U.S. Secretary of the Navy, and many corporate clients. He writes about entrepreneurship, technology, food and other areas of great personal interest.