Is There Really A Best State To Form An LLC In?


If you start searching the Internet for information on the best state to form your
The truth is, for most entrepreneurs, the best state to form
The most important principle to keep in mind when you are choosing the state in which to form your
Of the 41 states that collect income tax, 36 have a “physical presence” rule. The physical presence rule comes down to this: If you live in a state, you will be considered to have earned your income there. No matter where you form your
Even in these states, you can easily form a “nexus” with the state that exposes you to both personal liabilities for court judgments and state income tax.
There is only one kind of business owner who is entirely free to choose the state with the best combination of registration costs and low or no state taxes. And there is one kind of business for which out-of-state formation of an
We’ll cover these exceptions to the rules a little later in this article. But for most new business owners, the first mistake to avoid having your efforts to avoid paying any state taxes at all wind up making you liable for double taxation.
How does the physical presence rule create the potential for double taxation of businesses that create their
Let’s suppose you are a California entrepreneur with a great idea for an online business. You can see eventually making a million dollars a year in profits. Thinking ahead, you don’t want to pay 12.3 percent of that to the State of California when you hit it big.
You also want to avoid hassles along the way. The Federal government gives you a tax break that allows you to treat your
But if you are your own employee in California, you will have to do things like (we’re not making this up) give yourself a one-hour lecture every year on safety in your workplace. You will need to be sure to point out to yourself the fire exits from your desk, and you will need to instruct yourself on how to avoid paper cuts.
Additionally, you will need to write yourself an employee handbook, give yourself a meal and rest breaks. You will also pay state disability insurance. And since January of 2020, the State of California will not allow you to avoid these obligations by becoming your own contractor.
The obvious solution for a California entrepreneur seems to be to form an
California is one of the majority of US states that has a physical presence test. If you live in the state, it is assumed that you work in that state. If you want protection for your personal assets and eligibility for federal breaks from an
One way to get
A resident of California can protect California assets with a Nevada
In this example, our California businessperson has gone through a lengthy process to protect assets in Nevada that she doesn’t have, and then repeated the process to protect assets she does have in California. Failing to protect her California assets could have catastrophic consequences. Creating an
The attraction of forming an
California has personal income tax rates up to a little over 12 percent. Nevada has no personal income tax at all. Until the beginning of 2018, an
However, since 2018, owners of LLCs have been able to elect to be taxed under Subchapter C or Subchapter S of the Internal Revenue Code. Making this election, as alluded above, allows the owners of LLCs to treat themselves as employees on salary.
They do not have to pay self-employment tax on profits over and above their wages. They get more significant deductions for certain business expenses if they file an election with the IRS for their
The problem is that the states will tax their LLCs that make this election as if they were corporations, too.
Nevada has a 5 percent tax on corporations. If a Nevada
For most situations, the value of the federal tax breaks exceeds the cost of state corporate income tax. In Alaska, which has no personal income tax but an unusually high corporate tax rate, it may not. There are other states in which entrepreneurs need to look closely at state corporate tax rates when they are setting up an out-of-state
It’s sometimes tempting to look at these situations and say, “It’s only a problem if the state tax agencies catch me.” Don’t take that risk. They’ll catch you. Typically, state income tax problems emerge after the resolution of a lawsuit, which is a time when you especially do not need tax problems.
There are also situations in which you will need to have registered your
But there are still situations in which it makes sense to create your
By definition, non-resident aliens do not reside in any US state or territory. Non-resident aliens also have the right to set up LLCs in any of the states of the United States, plus the District of Columbia and US territories. Non-resident aliens may want to set up LLCs in the United States to create an entity for banking and to distinguish their business assets from any personal assets they hold in the United States.
For example, if you have both an online business that generates income in the United States and a condo you use when you visit the United States, you may want to make sure that your condo is protected as your non-business property.
The US can be one of the world’s best tax havens for non-resident business owners. No federal or state taxes are charged against profits earned without a “dependent agent” in the United States. A dependent agent is a person you employ substantially fulltime to increase your income, as contrasted to doing something purely administrative, like making sure payments are deposited into your bank account.
In these situations, some states are better for forming your
The IRS does not allow you to claim Subchapter S benefits, so corporate income taxes in those states are not a consideration.
The lowest up-front costs for forming your
Answer: The least expensive state over the long run is New Mexico, followed by Texas, then Wyoming and New Hampshire (tied), then Florida. The lowest annual reporting cost is with New Mexico.
The reason you wouldn’t form your
Non-resident aliens want to avoid any appearance of a “nexus” of their personal activities and their business activities in any state. But usually, the best state for forming an
Rental real estate can be riskier than most investors realize. Here’s a true story.
Jane (not her real name) inherited an apartment building and her parents’ home in Austin, Texas. One of her tenants fell asleep while smoking a joint and deep-frying a Thanksgiving turkey indoors. The apartment building burned down and he tenant was horribly burned. The tenant sued on the theory that Jane should have prevented her from falling asleep while smoking a joint while deep-frying a turkey over an open gas flame in a studio apartment.
She had fire insurance to cover her loss of the apartment building, but she did not have liability coverage to cover her legal fees. Jane won her court case, but she had to file bankruptcy to cover the legal expenses and, despite her state’s homestead protection laws, also lost her parents’ house.
Jane could have prevented bankruptcy by forming an
Jane could have had an additional layer of protection by forming an
The purpose of this arrangement is not to prevent legitimate plaintiffs from getting what they are due. The use of having an out-of-state
You don’t want the
New Mexico, Texas, Wyoming, New Hampshire, and Florida top the list. Because the courts in Wyoming tend to be friendly to business owners, many real estate investors form their LLCs in Wyoming.
Complex and changing laws govern issues of taxes and liability. It pays to consult with an attorney and a tax planner who can give careful attention to your unique situation. The general principle for forming LLCs is that it is best to form your
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