By UpCounsel Startup Attorney Patrick Jones
With Contributions from Michael Kidd

One common comment we often hear from international and domestic startups alike is: We want to form a Delaware corporation. Our response is: Why?

If the answer is, “Because we formed the company through Stripe Atlas, and that was the only choice we had,” fine. Or, if an investor wants to give you $5,000,000, and he insists that the company be formed as a Delaware corporation, we get that, too. Those are both valid reasons for forming your company as a Delaware corporation.

At 8.7%, however, Delaware assesses among the highest corporate tax rates in the United States. If your company is going to provide services or sell products to clients and customers all over the U.S. (and perhaps globally), then we recommend that you consider alternative, tax and filing fee friendly jurisdictions, like Nevada, Texas, Wyoming and Arizona.

Historically, Delaware was a popular choice because it was one of the first states to adopt corporate laws that provided a high level of limited liability for directors and shareholders. And, the Delaware courts interpreting those laws produced decisions that provided strong precedent for a clear demarcation of corporate and individual assets and liabilities.

Today, however, nearly every jurisdiction has copied Delaware’s statutes. And, hundreds of thousands of judicial decisions are published every year, so it is unlikely that your attorney would be unable to find a case interpreting a relevant provision of Nevada or Arizona corporate law. Even if that were the case, other jurisdictions routinely look to Delaware case law when their own case law is deficient.

Of course, forming your company in a given state does not necessarily mean that it will be subject to taxation (favorable or otherwise) in only that state. Regardless of where your company is formed, you could generate a tax liability in any state in which your business activities occur. Depending on the rules of the jurisdiction, business activities that could result in a “nexus,” loosely defined as a “sufficient presence to generate a tax liability,” do not necessarily require having a brick-and-mortar storefront; an internet sales company could unintentionally create nexus in a tax unfriendly state by employing workers, owning or leasing business property (even a warehouse), actively marketing products or services, maintaining inventory in a state or even generating substantial sales in that state.

“The rules for determining whether your business activities create nexus vary from state to state, as do the ways that jurisdictions tax companies that have nexus. For example, one state may levy a sales or use tax in lieu of or in addition to an income tax, while states such as Texas, which doesn’t have a traditional income tax, may impose a franchise tax based on your company’s gross receipts,” explained Michael Kidd, CPA and Partner at Mowery & Schoenfeld, LLC. “If you want to ensure that your company is taxed only in a ‘tax free’ jurisdiction, like Nevada, Texas or Wyoming, you need to carefully analyze the nexus guidelines in any state that your business activities touch before you initiate operations.”

With the increased administrative requirements, poor online services, and a high tax rate, Delaware is no longer the leader when it comes to favorable jurisdictions in which to form a new company. It is difficult enough to create a business that generates an annual profit; there is absolutely no point of giving more of that profit than necessary to the tax man!

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About the author

Patrick Jones

Patrick Jones

Patrick has more than 17 years of practice working with clients ranging from startups to Fortune 50 companies on matters involving corporate formation, commercial transactions, business litigation, corporate restructuring, and appeals. In the past two years he has taken and defended dozens of depositions, and “first chaired” multi-day trials in Illinois and Arizona.

He is also a partner with Universal Corporate Services, a firm that specializes in assisting non-U.S. individuals and companies with establishing U.S. operations.

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