Which Is the Best State to Form an LLC?
Are you ready to form a limited liability company (LLC), but you’re not sure which state is the best choice for your business to form in? Lots of entrepreneurs ask us where the best state to form an LLC is, but the answer isn’t quite so simple. Depending on where your company is located and what line of business you’re in, the answer could vary considerably.
In this guide, we’ll discuss which states are the most (and least!) LLC-friendly, and also whether you should form an LLC in your home state or in another location. By the time you’re done reading, we’re confident that you’ll know where you should form your new business.
What is an LLC?
The limited liability company occupies the middle ground between the formalities of a corporation and the simplicity of a sole proprietorship or general partnership. The most common reason to form an LLC is the way this business structure provides personal asset protection. If your LLC is sued, creditors are limited to pursuing your business assets, while your personal assets like your house, car, and bank accounts are protected. If you own a sole proprietorship or a general partnership, this is not the case.
The formation process for an LLC is much less expensive and complicated than that of a corporation, and ongoing maintenance is considerably simpler as well. In addition, LLC owners get to choose how they want their businesses to be taxed. You can either choose pass-through taxation like a partnership ― which avoids the double taxation of most corporations, in which your profits are taxed both on your corporate return and your personal return ― or you can elect C corporation or S corporation taxation.
Domestic LLC vs Foreign LLC
The first question regarding which state to form your business in is whether you’re trying to form a domestic LLC or a foreign LLC. A domestic LLC is one that’s formed in the same state as your company’s primary business location, whereas a foreign LLC is formed in any other state.
If you don’t already have a domestic LLC, forming a foreign LLC is a bit of a hassle. If you want to form an LLC in a state other than your own while also doing business in your home state, you’ll need to complete your formation in the state of your choice and also register as a foreign LLC in your home state. This means double the formation costs, and also twice as many ongoing compliance fees.
It’s a common topic to read about states that are more or less favorable for LLC formations, and we’ll dive into those details in the next section. It’s important to note though that we typically advise entrepreneurs to form businesses in the state they’re based in.
Which States Have a Favorable Business Climate for LLCs?
If you’re still interested in pursuing LLC formation in a state other than your own, there are some states that are objectively better options than others for LLC formations. By taking a look at business tax rates, formation fees, and ongoing compliance costs, we can determine which states have the most friendly environments for LLCs.
Here are a few of our top choices:
Wyoming’s popularity is easy to understand, as they don’t charge income taxes on businesses or individuals. This state also has an extremely low sales tax rate of just 4%. Wyoming also offers a high degree of anonymity for entrepreneurs looking to maintain their privacy, as they offer a lifetime proxy. This means that you can designate someone other than yourself to issue votes on company business, keeping your identity private if you so choose. Finally, Wyoming has a relatively low $100 formation fee, and a $50 minimum annual report fee.
While Delaware is certainly more popular for corporation formations than LLC formations, this state still has some unique advantages that make it an interesting option for entrepreneurs looking to create a new LLC. You can form an LLC for just $90 in Delaware, and they also don’t charge taxes on out-of-state income, although the $300 annual tax is a little bit on the high side. The reason for Delaware’s popularity is the Chancery Court, a business-only court system. If your business is sued, you can usually rely on your case getting heard much more quickly than in most other states, and your judge will likely be a true expert on business law.
Nevada is an increasingly popular choice for LLC formations, thanks in large part to the fact that they have no business taxes or income taxes. In addition, similar to Wyoming, Nevada also allows entrepreneurs a high degree of privacy, as they permit LLC owners to maintain anonymity with any business filing. This state also has very low formation fees for LLCs ($75), although their $150 annual report and $200 business license fee are slightly high annual expenses.
While Wyoming, Delaware, and Nevada are our favorites, there are plenty of other business-friendly states out there that allow you to form and maintain LLCs at reasonable rates. Here are a couple of the states that we think are strong options for LLC formations, but for one reason or another fall a bit short of what our top three states have to offer:
- Oregon: There’s no sales tax in Oregon, which is always an inviting attribute. This state also has reasonable $100 startup fees, and their annual reports also cost $100.
- South Dakota: In this state, there’s no business tax or individual income tax, which can obviously keep your costs down. South Dakota’s $150 formation fee isn’t the cheapest available, but their annual reports cost just $50.
Which States Have Difficult Business Climates for LLCs?
Just like some states make life easier for entrepreneurs, there are some states that are much more expensive. If you’re located in one of these states, it still may be advisable to start your LLC there, but for most people located outside these states, there’s really no reason to test the waters of these pricey options.
The Garden State has a high corporate tax rate of 9%, and their individual income tax rate starts at 3.5% and goes all the way up to 11.8% for wealthy individuals. New Jersey also has a high 6.625% sales tax. Their startup ($125) and annual report ($50) fees are pretty reasonable, but this isn’t enough to overcome the state’s high tax rates.
While their formation fee of $70 is super-reasonable, California has some of the highest franchise tax rates in the nation, as every business is required to pay a minimum of $800 annually. California also charges corporate taxes at the high rate of 8.84%, and their individual income tax rate goes all the way up to 13.3%, which is the highest rate in America. Throw in their 7.25% sales tax, and it’s clear that this is not an inviting state to form an LLC in.
Many entrepreneurs seem to overthink the question of where to form their LLCs, as for most people, forming an LLC in your home state is usually the right move. Especially if you have a physical office or retail store in your home state, it often doesn’t make much sense to form your business elsewhere.
However, there are also some states that are objectively friendlier climates for LLC formation and maintenance than others. If you have flexibility due to your business type or location, it couldn’t hurt to be aware of which states are more and less favorable to LLCs.
Whether you choose to form your LLC in your home state or elsewhere, we wish you the best of luck in your business endeavors!