By: Narmada Murugan

When choosing a domicile in which to form an entity, the default choices tend to be one’s familiar home state, where they currently are and/or plan to actually conduct their business, or the buzzy-choice of Delaware. Even many non-lawyers and business people are aware of the popular choice of Delaware (and infamously, the Cayman Islands) as centers of business activity. Why is this so? 

 

Simply put, Delaware has grown as a favorable choice due to its business-friendly laws and courts, in comparison to most other states. Delaware houses the one and only Court of Chancery — “where judges (not juries) focus exclusively on business law” — which has created their extremely specific and business-friendly body of law. Delaware’s “General Corporation Law” is anti-regulation, limits liability of corporate executives, and is generally pro-business. Delaware also has “The Division of Corporations,” an agency run by its secretary of state that “allows qualified registered agents to view corporate documents, submit filings, print plain or certified documents, and certificates of good standing – all online. Open until midnight, the agency handles one hour, two hour, same day and 24-hour turnarounds for important documents.”

 

Now, Nevada is joining Delaware in this desirable category of being advantageous for business, especially in the purview of West coast entrepreneurs.  Nevada is second to Delaware for the number of out-of-state corporations formed there. Nevada has even created “SilverFlume,” a business portal run by their secretary of state – closely mimicking the Delaware Division of Corporations as a one-stop shop expediting procedural needs. Nevada is also fairly protective of corporate executives: “As of 2012, the corporate veil was pierced only twice in Nevada.” The concept of piercing the corporate veil essentially is tied to pass-through liability: a corporation’s conduct is connected to its controlling officers and shareholders. Nevada also has an extremely appealing tax structure for businesses due to its lack of franchise tax, corporate income tax, and personal income tax. 

 

Delaware is still the most popular choice by far, with over 60% of Fortune 500 companies being incorporated there. While that is appealing for many entrepreneurs with iconic companies being Delaware C-Corporation,as you know, beware of cookie cutter legal advice for your business. How do you know where is right for you? 

 

Most Important Factors an Entrepreneur Should Consider When Choosing Where to Form Their Business:

  • Filing Requirements and Costs
    • It is cheaper to form an LLC in Delaware with the minimum filing fee at $90. 
    • Although the minimum cost to establish a corporation in Nevada is $400 it includes the list of officers and the business license. (DE does not require a business license.)
  • Qualifying as a foreign corporation
    • You must register as a foreign corporation in any state you are doing business in outside of the state that you are incorporated in. This means if you are incorporated in Delaware or Nevada but are doing business in Michigan, you must qualify as a foreign corporation in Michigan.
    • This requires further initial and ongoing costs in each additional state you are conducting business in addition to the initial and ongoing fees in your state of incorporation.
  • Tax 
    • How is your respective entity, a corporation or LLC, taxed? What (if any) are the additional tax requirements if you are conducting business in delaware? What is the business or personal income tax? Is there a minimum tax or franchise tax?
    • Depending on your business plan and projected revenue over the next couple of years, what do you estimate your total tax liability to be?
  • Are there specific regulatory benefits or difficulties (depending on your entity type) in this state?
  • Asset and Privacy Protection

 

Now with this in mind, how do Delaware and Nevada compare? According to them:

 

Delaware Nevada
  • Widely renowned for its flexible business law — with the specialists to match
  • Court of Chancery
  • Case Law Precedent (such as the business judgement rule)
  • No state corporate income tax for companies formed in the state that do not transact business there 
  • Non-residents pay no personal income tax
  • Franchise Tax
  • Favorable tax requirements for dealing with stocks/shareholders
  • No state taxes for stock shares owned by non-residents
  • No Corporate Income Tax 
  • No Taxes on Corporate Shares 
  • No Franchise Tax 
  • No Personal Income Tax 
  • Nominal Annual Fees 
  • Nevada corporations may purchase, hold, sell or transfer shares of its own stock. 
  • Nevada corporations may issue stock for capital, services, personal property, or real estate, including leases and options. The directors may determine the value of any of these transactions, and their decision is final. 
  • No Franchise Tax on Income 
  • No Inheritance or Gift Tax 
  • No Unitary Tax 
  • No Estate Tax 
  • Competitive Sales and Property Tax Rates 
  • Minimal Employer Payroll Tax – 0.7% of gross wages with deductions for employer paid health insurance
    Nevada’s Business Court 
  • Developed on the Delaware model, the Business Court in Nevada minimizes the time, cost and risks of commercial litigation by: 
    • Early, comprehensive case management 
    • Active judicial participation in settlement 
    • Priority for hearing settings to avoid business disruption 
    • Predictability of legal decisions in commercial matters 

 

Generally speaking… Delaware proudly claims that “[its] companies have a better reputation in the business community, as judged by the United States Chamber of Commerce.” Nevada is seen to be better for small businesses and tends to be more popular with companies on the West coast (with companies on the East coast and midwest erring towards the more conservative Delaware choice).

 

West Coast Business Caveat: Although Nevada is becoming an increasingly popular choice for Californian companies, due to its tax benefits in particular, beware of CA’s “pseudo foreign” corporation statutes. 

A foreign corporation transacting business in California is a “pseudo foreign” corporation if (CORP §2115(a)):

  1. the average of the property factor, the payroll factor, and the sales factor (as defined in Sections 25129, 25132, and 25134 of the Revenue and Taxation Code) with respect to it is more than 50 percent during its latest full income year; and
  2. more than one-half of its outstanding voting securities are held of record by persons having addresses in this state appearing on the books of the corporation on the record date for the latest meeting of shareholders held during its latest full income year or, if no meeting was held during that year, on the last day of the latest full income year.

If it falls into the above, California law in certain areas supersedes the law of the jurisdiction in which the corporation is incorporated (CORP §2115(b)). Some of which are:

  • Annual election of directors
  • Removal of and filling of director vacancies 
  • Director’s standard of care 
  • Liability of directors for unlawful distributions 
  • Indemnification of directors, officers, and others 
  • Limitations on corporate distributions in cash or property 
  • Liability of shareholders for unlawful distributions 
  • Annual shareholders’ meetings 
  • Shareholders’ right to cumulate votes at any election of directors 
  • Supermajority vote requirement 
  • Limitations on sales of assets, merger, and reorganizations 
  • Records and reports
  • Rights of inspection 

 

While the information presented in this piece has hopefully been helpful and educational, there are so many factors that make an incorporation decision – right or wrong, better or worse – for your business. For many entrepreneurs starting a small business, the best and cheapest way usually is to begin as a local LLC, however as you scale up & out incorporating in these business hubs of Delaware or Nevada may be right for you!