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How And Where To Incorporate

So far, we’ve learned that a corporation is a legal fiction that is used to protect one’s personal assets. A Limited Liability Company serves a similar function, but is easier to form and requires less work to operate while offering many of the same protections as C or an S Corporation. As a corporation, you have certain obligations to set up operating procedures and hold annual meetings, and your accounting gets a lot more complicated. However, as a corporation, it’s a lot easier to raise capital through the sale of shares.

We’ve also learned that different states have different regulations governing corporate entities. If you plan to do business in any state other than your own, it is required that you have a representative – known as a “designated agent” – as well as a physical address in each state where you plan to do business.

Whether you decide on an LLC or an S-Corporation really depends on a number of factors. You might ask yourself:

• Does this business have a great deal of growth potential? Could I be sitting on top of the next Ebay or Amazon.com?

• Am I providing goods or services that people run the risk of injury using? Could I be sued for damages arising from the use of my service or product?

• Can I deal with large amounts of paperwork? Alternatively, am I willing to incur the expense of hiring a professional accountant?

• Will I be conducting business outside of my home state?

If your answer was “no” to all four, chances are the LLC entity will work just fine for your business. If, for instance, you operate a website that is a “portal” – in other words, a collection of related links that websites pay you to maintain or advertise on because yours gets a great deal of traffic (examples would be Restaurant.com or RV.net), chances are small that you’ll ever be sued unless you break some type of contractual agreement (and that would never happen to you, right?).

On the other hand, if you answered “yes” to one or more of these, you should seriously consider forming an S-Corporation.

Once you’ve decided to “take the plunge,” you’ll need to decide in which state you wish to incorporate. If you’re not planning to do business outside your home state, there’s really little reason to incorporate elsewhere. However, it’s a fact that some states are more “corporate-friendly” than others. They offer greater protections, fewer regulations, and greater privacy. It’s one of the reasons that most businesses operating nationwide incorporate in Delaware or Nevada.

Incorporating In Delaware

If you recall our brief review of American History, you’ll remember that the great state of Delaware was one of the first during the last half of the nineteenth century to pass legislation that was extremely business-friendly, and remains a corporate haven to the present day. It’s small wonder that nearly 60% of all Fortune 500 companies and over 50% of public U.S. corporations are registered in Delaware. With well over a century of experience, Delaware has the most extensive body of corporate case law of any state in the Union.

Legal matters related to corporations in Delaware are overseen by Delaware’s Chancery Court - which is a “court of equity” as opposed to a “court of law.” As such, there is no jury. All legal decisions are rendered in writing by the judge (known as a “chancellor” in this case), and cases tend to move more quickly through the system. Whereas a Court of Law can provide only monetary relief on a given issue, a Chancery Court can actually issue injunctions prohibiting or requiring a course of action – which is very handy when a major acquisition or hostile takeover is imminent.

Delaware law also allows for some flexibility if yours is a business that offers more than one type of service. For example, perhaps you make part of your living as a computer graphic designer, part of it as a professional blogger, and yet another part of it fixing motorcycles – and on top of that, you get royalties from published writings and play guitar in a country-western band on the weekends. This can make for some very complicated bookkeeping, and technically necessitates the formation of a separate business entity for each.

Delaware law allows you to create what is known as a “Serial LLC,” which can cover several lines of business under one entity while treating them separately from each other for purposes of liability. Originally, the purpose of Delaware’s Series LLC law was to allow money management funds to operate as LLCs. Today, people who own multiple rental and/or investment properties are using this law to simplify their own bookkeeping and avoid the necessity of creating a separate entity for each. You can read the full text of Delaware’s Series LLC Law at http://www.delcode.state.de.us/title6/c018/sc02/index.htm. You’ll probably want to consult with your tax advisor, who can tell you exactly how formation of a Serial LLC can help you in your state, if at all.

Beyond that, other advantages include a relatively low initial fee for incorporating, which may be under $90. Should you decide to issue stock, you’ll also find that such shares are tax exempt in Delaware, providing you – as the owner of the corporation – do not reside there.

As far as transacting business over the World Wide Web, the State of Delaware does not treat this any differently for tax reasons than any other type of foreign (out-of-state) business – unless your server is physically located in Delaware. According to state law, this would create what is called “nexus” – meaning that your company would be treated as an in-state corporation for tax purposes.

This brings us to some of the disadvantages of incorporating in Delaware. There is a franchise tax – based on the number of shares you have issued or the amount of your assets – that may be substantially higher than that of other states which levy such a tax (not all do). This tax – which starts out at a minimum of $50 – must be paid by 1 March every year. Failure to do so will result in an additional $60 penalty and an annual interest rate of 18% applied until the balance is paid in full. In addition, there is an annual Registered Agent Fee that must be paid at the same time. This fee is $95 per year for corporations in the 48 contiguous United States, and $130 for those located in Alaska, Hawaii or a U.S. territory. On top of all that, there is a $200 annual tax that is due 1 June of every year.

Essentially, if you incorporate in Delaware, you’ll be paying between $345 and $380 every year at a minimum to keep your charter – and if you issue stock or your company’s assets go up substantially, this tax bill could get significantly higher. (Incidentally, you may have heard that Delaware does not charge income tax on corporations that do not operate in Delaware. This is true – but it is also true of every other state in the Union, since no state taxes the income of a corporation unless it is actually doing business in that state.)

The Delaware Division of Corporations charges a fee for information regarding the status of an entity – i.e., if your own corporation owes anything in the way of fees or taxes (essentially, they’re charging you a fee for telling you whether or not you owe a fee).

Finally, there have been complaints – not fully substantiated – that the Delaware Division of Corporations gives preferential treatment to some registered agent service providers over others. If you plan to use such a service, you’ll want to do a bit of due diligence before signing on.

Incorporating In Nevada

Nevada is another state known for being a corporate haven, and is the state of choice for many public and private corporations located in the western U.S. Like Delaware, there are several advantages – and a few disadvantages – to having your business entity charted in Nevada. Before going into that however, it’s worthwhile to explore some of the misconceptions surrounding the reasons as to why one should incorporate in Nevada.

Misconception #1: “Nevada Has No State Income Tax”

Indeed it doesn’t – and as long as your business is physically located and operated in the state of Nevada and your employees are legal Nevada residents, you’ll benefit. It won’t help you when it comes to registering in your home state as a “foreign entity” if your state does have an income tax, however.

Misconception #2: “Nevada Protects Your Privacy”

Only to a minor degree. Your shareholders are not listed in the records of the Nevada Secretary of State, but can be if you obtain a business license in Nevada – and definitely in your home state, regardless.

Misconception #3: “Nevada Doesn’t Exchange Info With The IRS”

True, but this only helps if your location and operations are confined to Nevada. If you have to register in any other state other than Texas however, those states DO have information exchange agreements with the IRS.

It’s That Old “Corporate Veil”

No doubt you’ve heard about “The Corporate Veil,” but you may not know exactly to what the term refers. Most people – especially in recent years – have come to believe the “Corporate Veil” is what allows multi-national corporations to abscond with billions of dollars of federal money or to raid employee pension accounts for the personal use of their CEO’s while never being held to account for any of it.

While this misconception is understandable in light of recent history, it’s hardly accurate. It actually goes back to the whole raison d’être for the formation of a corporate entity – which is to shield one’s personal assets and property from being seized to cover liabilities of the business. There are situations however in which a court may decide that it is indeed completely appropriate to hold shareholders or members liable for a corporation’s debts. This can occur if a court decides that it would be unfair to a plaintiff to simply hold a corporation liable. This doctrine is called “Piercing the Corporate Veil,” and is usually invoked if there is evidence a shareholder attempted to pass personal liabilities on to the corporate entity. The “Corporate Veil” is the legal presumption of limited liability. Since the burden of proof is on the plaintiffs, these courts are highly reluctant to ”pierce the corporate veil,” and the decision to do so is usually made on a case-by-case basis.

A corporate veil may be pierced if the court decides it is “too thinly capitalized” – in other words, the corporation doesn’t appear to have enough money in the bank to operate properly. Here’s where it pays to incorporate in Nevada; capitalization levels as low as $200 have been found to be adequate. In fact, the corporate veil has been pierced in Nevada only two times in the past quarter-century – and both cases involved a corporation that was operating in Nevada and had committed fraud against a Nevada resident. (In California on the other hand, piercing the corporate veil is common – especially when it comes to “foreign,” i.e., out-of-state corporations.)

In Nevada, a plaintiff must prove three things in order to pierce your corporate veil:

1. The corporation must be shown to have no separate existence from the principal, and is therefore under undue influence of that principal;

2. The plaintiff must show that the line between interest and ownership has been blurred, made permeable, or removed altogether;

3. This proof must clearly show that adhering to the legal fiction of the corporation as separate entity would promote or sanction a fraud under the given circumstances.

Again, this burden of proof is on the plaintiff – and s/he must prove all three circumstances were present. Otherwise, a Nevada court will dismiss the case altogether.

Other Advantages To Nevada

As a small, possibly single-person corporation, you’ll also be interested to know that in Nevada, all of the corporate offices – President, Secretary, Treasurer – can be held by a single person. Under most state charters, your corporation is required to have at least these three officers, but as a Nevada corporation, you have the option of being the sole director.

You always have the option of bringing other members and shareholders on board, of course – and when it comes to liability issues, Nevada again offers a great advantage. This is Nevada’s abolition of what is known as “joint and several liabilities.” Normally in a liability judgment, all members of the corporation are held equally responsible, regardless of how much each individual may have had to do with causing the actual damages – if anything. This means for example that if one of your members goes out and markets a defective product or performs a service that is inadequate – with or without your knowledge – you and all shareholders can be held equally responsible for damages. Under Nevada laws, however, the courts must assign a percentage of the liability to each defendant, who are required to pay a share of the total judgment equal only to his or her actual responsibility.

There are several other reasons you may want to consider incorporating in Nevada, although many of these helpful only if your business grows to a substantial size and/or plans to issue stock. Further information on these is available at the Nevada Secretary of State Website, which you can visit at http://www.sos.state.nv./comm_rec/cnrslink.html. As a small business or individual however, you’ll be interested to know that filing fees in Nevada are considerably lower than most other states, running at $125 at the time of this writing. (Compare this with states such as Massachusetts and California, where these fees run $500 and $800, respectively.)

Of further interest to the small netpreneur is the fact that in Nevada, an LLC is treated just like a corporation – meaning if you choose to form an LLC rather than a corporate entity, you’ll enjoy all of the same protections. Nevada is also one of 36 states in which an LLC may be formed for “any lawful purpose” – including the holding of one’s assets. LLCs in any of the following states must be formed for the purposes of doing business:

• California

• Indiana

• Iowa

• Louisiana

• Maryland

• Michigan

• Minnesota

• New York

• North Dakota

• Oregon

• Pennsylvania

• Rhode Island

• Texas

• Virginia

Because Nevada statutes allow for the creation of an LLC for any lawful purpose, an extra layer of privacy and protection of one’s assets is in place that is not available in the fourteen states named above.

Incorporating In Other States

Delaware and Nevada by far have the most favorable corporate and business laws on the books. You may however find a reason to incorporate or form an LLC elsewhere, and since each state’s laws are different, some may actually be better for your type of business and situation than others.

Arizona

Starting up a business entity in Arizona is also significantly less compared to other states, and can start out to be as little as $50. Furthermore, as of January of 2001, the state of Arizona lowered its corporate tax rate to a flat 6.968%, regardless of profits or losses throughout the year. In addition, certain industries receive preferential treatment and incentives, although these generally must be businesses operating within the State of Arizona. There is no entity level tax on an LLC, and your tax return – Form 65 – can be turned in on 15 April.

Florida

Florida has the advantage of tax laws that are highly favorable to businesses. Not only are personal income taxes prohibited by the provisions of the Florida state constitution, there is no corporate income tax on S Corporations.

New York

The big advantage to incorporating in New York State is privacy; there is no requirement stating that corporate officers must be listed in the articles of incorporation. Shareholders enjoy limited personal liability under New York law. Normally, the corporation pays a state franchise tax as well as a tax on corporate income, and shareholders pay a tax on the portion of that income they receive as dividends. However, there is a limited exception made for S Corporations. Beyond that, if you are located and/or intend to operate in the State of New York, several cities around the state have incentives called “Empire Zones.” Visit http://www.nylovesbiz.com/ for more information.

Where To Get Started

If all of this seems overwhelming, you’ll be glad to know that there is no shortage of organizations that are willing and eager to help you get started with the process. None of the paperwork requires a legal professional and virtually all of it can be filled out by anyone. As you’ve learned however, business law can be highly complex, and it can be easy to make costly mistakes.

Option A: Hire a Professional

The logical place to start would be with your tax advisor or accountant. If you do not have one of these, it’s best to shop around and even interview a few of them. Find out what their training is, how much experience they’ve had, and what they know about setting up business entities outside of your home state.

You can also consult with and hire an attorney. At prices starting at around $230 per hour, this is not an option for very many small businesses. Many attorneys will give you a 30 minute initial consultation for free, but this may not be nearly enough time to set up your chosen business entity correctly. Fortunately, recent years have seen the birth of a number of “legal clubs” or “legal plans” offered by several companies around the country. These plans work very much like health insurance; for a monthly fee that ranges from $12 to $45 per month, you’ll have access to a qualified law firm in your state from which you can get a specified number of hours of service and/or representation each year, as well as a discount on hours and areas of the law beyond those covered by your particular plan. Some of these “legal plans” are available through trade associations or non-profit organizations such as auto clubs.

Option B: Hire Para-Pros

The most popular – and economical - route these days is to go through a business specializing in the incorporation process. There are many reputable – as well as a few not-so-reputable - paralegal organizations online that can provide assistance in navigating the maze of paperwork involved in setting up your C or S Corporation, as well as establish your presence in all states in which you plan to do business. Entering terms such as “legal help setting up corporations” or “incorporate my small business” into any major search engine should bring up a fair number of these organizations. Fees and range of services can vary widely, so it definitely pays to shop around. Also keep in mind that the fees charged by these organizations – which can be anywhere from $35 to over $500 – are on top of any state incorporation and filing fees.

Click&Inc can incorporate a business in 24 hours in all 50 states and save over $543 in legal fees. Our services include customized articles, bylaws, minutes, completed EIN form and personalized stock certificates. save taxes by incorporating

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