In your search for the best state you form your LLC, you may have heard statements like this:
“You should form your LLC in Nevada…”
“Wyoming is the best place to form an LLC!”
“Deleware is where all companies should be formed.”
I hear it often.
Are there benefits to forming an LLC in a state other than your own?
For most small business owners, forming an LLC (or other entity) in another state reflects a general misunderstanding of how income tax works.
Most small businesses are “pass-through” entities. That means that profits from the business are not taxed at the business level. They “pass-through” to the individual and are taxed with all of your other income on your individual tax return.
For example, say you are a member of an S corporation or multi-member LLC. There may be fees associated with operating those entities, the entities themselves are generally not taxed directly.
In other words, the business doesn’t pay taxes. You do.
The entity will issue you a K-1 (think of it as a W-2 from your business). It shows your share of the profits that you’ll report on your individual taxes.
Reasons you may hear about Nevada, Wyoming, or some other state generally include the following:
- The state is business friendly
- There is no state income tax
- It allows for anonymity on your filing documents
Sounds good, right? Not so fast…
Forming an LLC in Another State
Here’s an example.
Let’s say I live in California, and I decide to form my LLC in Nevada for tax savings (NV has no state income tax).
When I do my taxes at tax time, all of the earnings from my business will “flow through” to me as the owner and are reported on my California state income tax return.
That’s right. Since I’m not a Nevada resident, I don’t benefit from the fact that Nevada has no state income tax.
Even though the business is registered in Nevada, none of the work is being performed there, so the business won’t be governed by Nevada’s tax rules.
I’m doing all the work in California, and you better believe that California will claim that income.
And not only that, since I don’t live in Nevada, I need to hire a “registered agent,” which is basically a third party (in the same state as where the business was formed) that can receive business correspondence on behalf of the business.
AND since the business is technically a Nevada entity doing business in California, I will need to register the business in California as a “foreign LLC.”
Oh, and that foreign LLC still has to pay that infamous $800 “franchise tax” that California charges its regular LLCs and file similar annual paperwork.
So I basically have to do everything I would already be doing anyway if I just registered a regular LLC in my home state of California. I’m just making it a whole lot more complicated by involving a another state.
Stick to Your State
All that is to say that for most us, who don’t live abroad or live a nomad lifestyle, it is generally best to form LLCs in our home states.
Remember, friends don’t let friends form LLCs out of state.