How Delaware Thrives as a Business Tax Haven
As the first of the original 13 U.S. colonies to ratify the constitution, Delaware is often referred to as “The First State.” You might say that Delaware is the leader of the pack, and it’s just as true in business as it is in politics and history. In fact, more than 50 percent of all incorporated businesses in the U.S. call Delaware their home. With a population just shy of 1 million, there are more businesses than people in the state!
Why Do Businesses Incorporate in Delaware?
Even as one of the smallest U.S. states (49th out of 50 for total land area), Delaware often packs the biggest punch for business owners. As a tax haven, Delaware offers numerous incentives to entrepreneurs, founders and CEOs. You don’t need to reside in Delaware to incorporate there; in fact, non-residents often reap the biggest rewards. While large companies, such as the more than 60 percent of Fortune 500 companies that call Delaware home, stand to gain the most, there are benefits for small corporations and LLCs as well. So, should you form your business in Delaware? Here’s what you need to know about tax sheltering in Delaware to make your decision:
Easy Formation and Operation
Filing your business in Delaware affords you one of the simplest, quickest formation processes in the country. It can be done online in under an hour with minimum hassle. The state’s flexible business statute also allows you to file without disclosing personal information, so your privacy is protected and the members or partners of your business feel secure. Additionally, the Delaware Court of Chancery, which has existed for more than 200 years, works to help business owners resolve disputes expediently, requiring only a judge to hear proceedings, rather than a lengthy process with a jury.
If you’re forming an LLC, you’ll also enjoy the flexibility of structuring your business the way you want, without jumping through hoops like documenting board meetings, shareholder meetings and bylaw provisions. The popularity of Delaware LLCs is growing thanks to the ease of the startup process. In 2019, LLCs represented 73 percent of all new formations in the state.
Tax season can strike fear in the hearts of even the most seasoned business owner, but in Delaware, the payoff is often worth it. For both large businesses and small, Delaware’s tax system is set up to help companies thrive, with benefits for corporations and LLCs.
No state taxes. There is no sales tax in Delaware, so any goods or services you purchase in the state for your business will not be subject to taxation. For business owners who reside outside of Delaware, there is no state income tax. As well, there are no property taxes or value-added taxes (VATs).
Flat fee taxes. In most states, franchise and LLC taxes are based on earned income; however, in Delaware, these taxes are a low, flat fee that’s paid annually. For LLCs, the tax is $300 dollars. For corporations, a franchise fee is calculated based on the type of corporation and the number of shares, with a minimum of $175–400, depending on the share reporting method. Corporations must also file an annual report, which is a $50 flat fee. LLCs are not required to file annual reports.
Pass-through taxation. Pass-through taxation is the default for LLCs, but it also applies to S Corps, with income or losses passed through to the shareholders. This type of taxation reduces the burden of taxable income on the business owner, and may reduce quarterly tax payments.
No taxes on intangible assets. If you reside in another state and your business creates anything that generates royalties, you can move ownership of those assets to Delaware. Intangible assets are anything that is not a physical object, but still holds value (artwork, photography, songs, books, etc.). If the asset is held in Delaware, the royalties generated will not be subject to any taxes.
Downsides of Forming a Business in Delaware
You’re probably thinking that filing your LLC or corporation in Delaware seems like a great idea, and for some businesses, it is. But a Delaware business isn’t right for everyone, and you might find that the benefits aren’t enough to keep you from filing from in your home state. Here are some of the biggest disadvantages to filing your business in Delaware:
Most benefits exist for larger companies. Corporate income tax only applies to C Corps, which means they reap the biggest rewards. LLCs and S Corps are not subject to this tax, so the fact that Delaware has no corporate income tax doesn’t mean much to them.
You’ll have to pay additional fees. If your company is owned in Delaware, but you actually do business in other states, you’ll need to file a Foreign Qualification for each. If you use different names in other states, you’ll also need to file a DBA (doing business as). And even if your business is formed in Delaware, if you conduct business in your state of residence (for example, in California), you will need to pay taxes in that state as well. Ultimately, any tax savings you may see from owning a business in Delaware may be eradicated by fees and other state taxes.
Your home state loses out. While Delaware is upheld as a tax utopia for many businesses, many states don’t see it that way. While companies flock to Delaware, surrounding states are losing vital tax revenue that supports necessary infrastructure, education and social support programs. If you want to see your home state thrive, it may be best to form your business there and contribute to its growth and prosperity.
If you’re ready to form your business in Delaware, we have all the information you need to get started. And if you’re looking for help this tax season, no matter where your business is located, our experts are here to help with Incfile’s accounting and tax services.