Once you’ve decided that an LLC is the optimal structure for your business, where to domicile it is the next question — what state to form your entity in. Many entrepreneurs assume that Delaware or Nevada is the best home for their LLC, due to the outsize buzz that these states get.
But the truth is that forming out of state often makes a lot less sense for an LLC than it does for a corporation. That’s because the LLC is a pass-through entity, meaning that the entity itself doesn’t pay taxes on its income. The income “passes through” to the founders’ personal tax returns, and the founders are responsible for paying taxes on their share of revenue collected by the company. For that reason, forming out-of-state doesn’t do much to minimize your tax liability, since you’ll be filing and paying taxes in your home state.
Additionally, if you form an out-of-state LLC, you’ll typically need to register in your home state, thereby increasing the annual fees and compliance for which you’ll be responsible. As an example, a New Yorker who forms a Delaware LLC will need to pay annual franchise taxes in both states, in addition to a registered agent fee in Delaware and his taxes in New York State.
That doesn’t mean that you should always form an LLC in your home state. In some situations an out-of-state LLC may warrant consideration. If you and your business partner live in different states, you may want to form in a neutral third state, especially if you plan to bring on additional members in other states.
States like Nevada and especially Delaware do have certain advantages: due to the large number of entities that have been filed there, the states have fairly robust bodies of case law, which can make litigation more predictable in the unfortunate event that your company ever gets sued (or needs to sue somebody else). Delaware even has a separate court system, called the Chancery Court, that deals largely with corporate-related disputes.
In any event, it’s important to check with a lawyer and a CPA to see which state makes the most sense for your business.