Updated July 6, 2020:

Delaware is the best state to incorporate an online business if you are forming a large corporation. Small businesses may find Nevada and Wyoming to be more favorable due to lower filing fees and taxes.

Deciding on Your State of Incorporation

While determining your business structure, you should also consider the place where you would be forming your business. You can create a corporation or a limited liability company (LLC) in any of the 50 states without having to live there.

The state of registration is basically the state where you file your formation documents. If you operate your business in a different state than where you formed it, you must register to conduct business in that state. The concept under which a business entity formed in a foreign state becomes eligible to conduct business in another state is commonly known as foreign qualification.

For example, let's say you live in California but incorporate your company in Nevada in order to take advantage of the favorable tax laws. Now if you also wish to conduct business in California under the same company, you will have to register your company as a foreign business entity in California. Thus, your company will be incorporated in Nevada and registered to conduct business in California. This will subject you to several fees and taxes including state income tax in California in addition to the annual fees in Nevada.

If yours is a small business with not more than five shareholders, it is always advisable to form an LLC or a corporation in the state where you work. This way, you will not have to file papers or pay fees in two different states. Irrespective of your state of formation, you are usually required to comply with the tax requirements of the state where you conduct business.

Incorporation or Formation Fees

Income tax, filing fees, and franchise taxes vary from state to state. You must usually pay a filing fee while submitting your incorporation or LLC formation papers. This fee is quite low in some states (for example, it's just $50 in Colorado and Arkansas), while it's very high in others (for example, its $450 in Connecticut). However, since it's a one-time fee, it doesn't have much impact in the long term.

Annual Fees

Most of the states charge you an annual fee while some may also charge you a franchise fee. In California, for instance, you must pay an annual fee of $20 for an LLC and $25 for a corporation, along with your annual report. In addition to this, you must also pay a franchise tax of a minimum of $800 per year. Franchise tax is the tax you pay to the state for allowing you to conduct business; you must pay it even if you incur losses.

The Best State to Incorporate

If you are on a tight budget, you should incorporate or form a company in a state where fees and taxes are low. Nevada and Wyoming have low filing fees, and neither of these two states has franchise taxes or state-level income taxes.

Wyoming offers business facilities comparable to those available in Nevada and even goes further when it comes to privacy protection. In fact, Wyoming was the first state that allowed forming an LLC. It's also among the few states that allow forming a single-member LLC. However, although its legislature is favorable for businesses, it does not have a well-established case law.

As you might have observed, most of the large corporations are incorporated in Delaware. It is the state where more than 50 percent of all the listed companies in the United States are incorporated.

Delaware has a pro-business legal system that includes a separate Chancery Court dedicated to resolving business disputes, thus allowing for a much quicker resolution than other states. Businesses also find it helpful to have their cases reviewed by a specialized business judge rather than a jury.

Another major benefit of incorporating in Delaware is that venture capitalists and big investors are usually familiar with Delaware's corporate law and therefore mostly prefer to deal with Delaware-incorporated companies.

Although Delaware may not be the cheapest state in terms of filing fees, it's quite efficient for large corporations that involve complex business matters like mergers, governance, and litigation. However, small businesses may not be able to take advantage of all the benefits offered by Delaware. If your company doesn't require venture capital or a business court, you may not benefit much from incorporating in Delaware unless it's your home state.

If you need help with the best state to incorporate an online business, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.