You may not think that incorporating in Delaware applies to you if you run a business outside the state, but if you keep reading you may find this article advantageous regardless of where you do business.
When starting a business, you face many different decisions. Some of these decisions may be minor and can easily be changed later. While other decisions can have a major impact on your business and how you pay taxes.
One of the more important decisions you’ll face is how to register your business entity. Registering your business as an LLC or incorporating allows you to enjoy certain legal benefits and tax advantages.
When registering your business, you will have a choice of states where you want your business registered. You can choose the same state as the one you are based in, but you can also choose another state.
Two popular options are to incorporate in Delaware or California. Both have their own benefits and drawbacks depending on your situation. Also, a Delaware corporation doing business in California will be subject to different business laws than one registered in California.
Below, we’ll go over the pros and cons of incorporating in each state so you can decide which is best for your new business.
Benefits Of Incorporating In Delaware
Delaware has been a top choice among businesses when it comes to incorporation. Delaware has built a robust system within the state to deal with regulations and legal disputes regarding incorporations.
Over time, they have built up the experience and legal infrastructure now trusted nationwide by small and Fortune 500 companies.
Delaware offers several key benefits for businesses looking to incorporate there, and we’ll go over them below.
Advantageous Corporate Laws
When people ask why businesses incorporate in Delaware, the answer has much to do with Delaware’s legal structure.
Delaware has been refining its corporate case laws for decades. Most of the business and financial community consider these laws very business-friendly.
Delaware’s laws are also extremely flexible, especially compared with other states, which can be far stricter.
Many rules and regulations exist around mergers and acquisitions, shareholder rights, and management choices. Larger corporations enjoy the flexibility in these areas to make decisions that are best for their company and shareholders instead of worrying about regulatory hurdles.
While newer businesses may not immediately take advantage of Delaware’s regulatory framework, as a business expands, they can become important.
Privacy For Officers
In today’s world, privacy is a top concern. Delaware allows companies to leave the names of officers and directors off of publicly available formation documents. General corporate forms are usually required to be public in many other states.
There can be many legitimate reasons why officers or directors would not want their names on publicly searchable documents. Incorporating a business in Delaware gives companies that option if they so choose.
Delaware Court of Chancery
Because Delaware caters to corporations, they have a dedicated court to handle corporate legal disputes and other corporate matters.
This court has the legal expertise and experience that gives companies the confidence that they will get a fair shake.
Some other states simply don’t have the legal experience to deal with complex corporate filings. In Delaware, the Court of Chancery uses judges with corporate experience instead of juries made up of the public.
No Tax On Corporations Based In Delaware
Corporations incorporated within Delaware are not subject to the state’s tax. This also applies to shareholders and their share ownership in a Delaware corporation.
Of course, the corporation still needs to pay all federal and local state taxes where they do business. However, Delaware does not impose any additional taxes at the corporate level.
Importantly, Delaware does charge a “franchise tax,” but this is more like a fee to incorporate in Delaware. The Delaware franchise tax is significantly less than paying state income tax elsewhere.
These tax benefits are sometimes the main reason corporations choose Delaware to incorporate but conduct business in other states.
Predictable Outcomes
Business owners and shareholders welcome any place that offers predictability amid the uncertainty that can fill the business world.
Because of Delaware’s extensive history in dealing with corporate laws, businesses can more easily predict the outcome of disputes or other issues.
This predictably helps to avoid wasted funds used on legal fights or other litigation that will be fruitless.
Disadvantages Of Incorporating In Delaware
One must consider Delaware incorporation’s disadvantages despite its many great benefits.
Out-of-State Fees & Complexity
If your business does not have a physical base in Delaware, you must prepare and maintain additional annual fees and paperwork.
Paying for a registered agent and other costs can complicate an already difficult incorporation process.
It’s important to consider if the added complexity of incorporating out-of-state is worth the benefits Delaware offers.
Franchise Tax
While the Delaware franchise tax and annual $50 report fee are generally less than paying state income taxes, it’s still something to consider.
If your home state has tax-friendly policies for local corporations, it may be better to incorporate there. You will also need a business license in your state of operations, which can incur a fee.
The Delaware franchise tax starts at $175, but depending on the size and revenue of your corporation, it can go up to $200K.
Complex Legal System
Delaware’s corporate legal system can benefit large corporations that can afford legal experts. However, smaller businesses may find the Delaware legal framework difficult to navigate.
Few Advantages For Smaller Businesses
For smaller businesses who just need to incorporate for liability protection and bookkeeping reasons, it may not be worth it to register in Delaware.
Many times, small businesses can save money by simply registering in their own state. This also simplifies their tax filings and corporate management.
Benefits Of Incorporating In California
California has the highest GDP of any state, so plenty of companies are doing business there.
Some businesses find it sensible to incorporate in California, especially if they have their headquarters there.
Below are some key benefits of incorporating in California.
Legitimacy
While countless legitimate corporations are registered in Delaware, it can be seen as a state where shareholders and officers “hide” from public disclosure. This is mostly a perception issue, but it is a factor.
Registering in California shows the officers and others involved in the business are open and transparent with their registration.
California can also hold a certain “x-factor” for branding, especially for tech, entertainment, or fashion industries.
Doing Business Where You Live
Living in California and registering your business there makes filing and paperwork for your corporation much easier.
It is also helpful if you’re a local business and conduct a majority of your business right there in the state.
If you’re a nationwide business, this benefit may not be as important.
Attract Investment Capital
California is the center of the world’s technology industry. This means there is no shortage of venture capital and other investors who reside and do business in the state.
If you’re a technology business, being registered in California can make it easier to network and attract investments.
Many startups sometimes choose to incorporate in Delaware, but there are some advantages for local California companies to register in their home state instead.
Certain Tax Incentives
Overall, California has high taxes on business, which is a negative. However, they do offer strong tax incentives for certain businesses and industries.
If your business is in one of these industries, the tax incentives may make it worthwhile to register in the state.
S Class Status
A California corporation can elect Class S status. Class S Status allows a corporation to be taxed like a partnership. In some cases, this may provide a tax advantage for some corporations.
California State Protections
California has strong consumer rights and shareholder rights protections. Some businesses may see these as burdensome. However, these strong protections can be welcome in other cases, depending on the industry and business model.
Disadvantages of Incorporating in California
Most disadvantages of incorporating in California revolve around taxes and specific regulations. The taxes are mostly universal, except for certain tax incentives. But California’s regulations are probably some of the most industry-specific in the nation.
Below are disadvantages to consider before incorporating in California
Taxes
California has the 7th highest state corporate tax rate at over 8%. While this isn’t unusually high compared to other large states, it is something to consider before incorporating there.
As noted, you will also want to check for various tax incentives in California, which, in some cases, can drastically offset standard taxes and fees.
High Fees
Even if your corporation doesn’t earn a penny, you must still pay the California Secretary of State’s minimum $800 franchise fee every year. For large businesses, this isn’t a big issue. But for smaller businesses, this may be a dealbreaker if they don’t plan on making a profit right away.
Industry-Specific Regulations
California is known for having stricter regulations specific to certain industries. If you do business in one of these highly regulated industries, it may not be worthwhile to incorporate in California.
Conversely, California is friendly towards certain industries, so regulations tend to be less strict and incentivized for those business owners.
Overall, California’s regulations are highly industry- and business-specific, creating a somewhat unbalanced corporate environment compared to Delaware.
Public Disclosure
Unlike Delaware, California requires corporations to disclose officers and directors on annual reports. These reports become a public record and are searchable by the general public via websites.
Board of Directors requirements
If your corporation has more than three shareholders, it requires having at least three members on the board of directors. For larger corporations, this isn’t a problem. But for smaller corporations, you may not have anyone to place on the board.
Delaware vs. California: LLC and Incorporation Key Differences
Whether you get your LLC in Delaware vs California can depend on the type and size of your business.
Below, we’ll review the key differences between a California vs Delaware LLC and incorporation.
Established Legal Framework
The business community generally considers Delaware to have the most corporate-friendly legal infrastructure. California is generally considered less friendly towards corporations, especially in industry-specific situations.
Fees
Incorporating a business in Delaware wins in this regard with lower overall fees. However, there may be other expenses related to registering out of state.
California has a mandatory $800 annual filing fee.
Overall, the cost of incorporating in Delaware is generally lower than in California.
Privacy Protections
Delaware allows individuals to keep corporate officers and directors private. Each year, California requires all companies to publicly disclose their officers and directors.
Cost of Doing Business
This is complex, but overall, Delaware will require you to register as a foreign entity if you do business in states other than Delaware. This can increase your overall costs of incorporation and ongoing legal costs.
Registering and doing business in California incurs specific expenses. California is well-known for having high property costs, labor costs, and taxes. These all contribute to the overall costs of doing business within the state.
Startup Friendly
Although California can foster a friendly startup environment, many investors may prefer businesses to register in Delaware. This holds particularly true if the company plans to go public or a larger corporation will acquire it.
Delaware’s longstanding legal precedents make mergers and acquisitions easier and more predictable.
Choosing The Right State To Incorporate Your New Business
Choosing the right state to incorporate can seem like a difficult choice, but by examining each aspect of incorporation, you can determine which state offers you the most benefit.
For example, you will want to examine each state’s tax implications. Look at things like the overall tax rate for the type of business entity you will be registering. Next, the state may offer tax incentives that you should check for.
After that are regulations; this may not be a big factor for some businesses. However, for other businesses, this may be a significant deciding factor. Incorporating in a state with a history of being unfriendly towards your industry is not a wise choice.
Finally, your business size will help you determine where to incorporate. For example, if you’re opening a small restaurant in California, there is likely no benefit to incorporation in Delaware.
On the other hand, if you’re starting a new tech company with ambitions of going worldwide, then Delaware may have advantages that make the extra filings worthwhile.
Overall, there’s no perfect state to incorporate. Instead, it’s about finding the best state that fits your business and future goals.
Frequently Asked Questions About Incorporating in Delaware vs. California: Pros and Cons
Incorporating a business means turning a sole proprietorship, a partnership, or LLC into a corporation. It becomes its own legal business structure and public entity set apart from the individuals who founded it. The incorporation process involves submitting a document known as the articles of incorporation to the state.
Because incorporating a business creates a distinct entity separate from personal assets, it affects how you pay taxes and can offer liability protection and tax advantages.
Delaware offers advantageous corporate laws, privacy for officers, a specialized Court of Chancery, no corporate state tax on, and more predictable legal outcomes. Comparatively, California provides legitimacy, convenience for local businesses, access to investment capital, certain tax incentives, and strong consumer and shareholder protections.
Drawbacks of incorporating in Delaware include out-of-state fees and complexity, franchise taxes, a complex legal system, and fewer advantages for smaller businesses.
