One of the most common questions I get from clients looking to set up an LLC is “what is the best state to form an LLC for online business?”
Fortunately, this is the one of the easiest decisions you will ever have to make.
In almost every situation, when it comes to LLC formation, your home state will be the best choice to register and form your LLC and take advantage of the liability protection that comes along with your LLC.
If you choose to file in a different state, a state where you don’t live or work, then you are creating more problems and headaches for yourself in the long run.
Fortunately, you have this article to help steer you in the right direction. My hope is that when you finish this article, you will have no doubt that filing an LLC in your home state is absolutely the right thing to do for your online business.
Let’s start with explaining the difference between a domestic LLC and a Foreign LLC.
Domestic LLC vs. Foreign LLC
When you form an LLC, you are doing so at the state level. Each state has its own unique rules and regulations regarding how LLCs are formed.
Because LLC’s are an entity created by state laws, the states need a method to distinguish between LLC’s that are registered within their state and LLC’s that are registered in a different state. These are referred to as Domestic LLC’s and Foreign LLC’s.
A domestic LLC is an LLC that is registered in the same state where it primarily operates and conducts business and has a physical presence.
A foreign LLC is an LLC that is registered in another state but conducts some business in the state where it registers as a foreign LLC.
This is important because if you decide to form an LLC in Wyoming, for example, but you live in North Carolina, then you will be required to form a Foreign LLC in North Carolina.
Here is what this means practically:
- You will have to pay to form two (2) separate LLC’s, one in Wyoming and one in your home state of North Carolina
- You must hire a registered agent in both states where you have an LLC
- You must keep track of reporting deadlines for both states
- You must pay annual reporting fees for each state where you have an LLC
Basically, by filing your LLC somewhere other than your home state, you are now obligating yourself to manage and pay for two limited liability companies, which means two times the cost, and two times the administrative headache to maintain both companies.
Consequences of Filing Outside Your Home State
New business owners who file LLC’s outside of their home state either do so without realizing the legal jeopardy they are putting themselves in, or falsely believe that they won’t get caught.
Each state has a different set of rules that require a company to register as a foreign LLC if and when that company is transacting business in their state. By “transacting business”, we do not mean that you merely have clients or customers in a given state. It would be impractical and burdensome to require an online business to register as a foreign LLC in every state where they have customers.
However, if you are living and working within a given state and the main office for your company is in your home state, then you are likely “transacting business” in a manner that would require you to register as a foreign LLC in your home state.
There are numerous penalties that can arise from someone operating an LLC in a certain state without registering that LLC as a foreign entity. These penalties can include, but are not limited to: fines, financial penalties, interest, court costs and lawsuits, invalidating the acts of the LLC, or even terminating your ability to form an LLC in that state for a period of time.
The consequences will vary depending on the state, but the penalties are codified in the LLC statutes of all 50 states.
Late Filing and Collection Fees
A relatively minor consequence of failing to register as a foreign LLC is the imposition of late filing and/or collection fees. However, even these penalties can be substantial.
Alaska, Indiana, Michigan, Nebraska, Nevada and Ohio all have have penalties of up to $10,000 for non-compliance.
In addition, the states of Colorado, Wisconsin and Wyoming impose a $5,000 fine, and Connecticut has a $3,600 fine per year fine.
Many more states have fines of at least $1,000.
In a real world example of this in action, in 2018, the Connecticut Secretary of State collected more than $1.3 million in fines and penalties from 275 companies illegally operating in Connecticut.
Injunctive Penalties
Another sanction that many states will us is to allow the attorney general, or any other person (a competitor, vendor or even a disgruntled customer, for example) to file a lawsuit that would stop the business from operating in the state.
Some states that allow this include Alabama, Arizona, Arkansas, Colorado, Delaware, Idaho, New Jersey, Ohio, Oklahoma, Rhode Island, Texas, and Utah, but this list is not exhaustive. Illinois will allow for automatic liens.
Voiding Contracts
In addition to costly fees and penalties, California also allows contracts to be voided if the company entered them during a period that it was out-of-compliance with either the requirements of the Secretary of State or of the California Franchise Tax Board.
This means that if you have a disgruntled client or customer who signed a contract with your business, but later learns that your LLC is not in good standing in the State of California, then they can have that contract voided as a result.
And in case you are wondering, “how would they find this out?” – all of this information is public record.
How to Transfer My LLC Back to My Home State?
If you are reading this article and so far realize that you may have made a mistake and filed your LLC somewhere else and now you need to move it back to your home state, then you aren’t alone.
And although this is not the most optimal of situations, it is not an impossible task to handle either.
You have three options to transfer your Limited Liability Company from the state you filed it in back to your home state.
- Register Your Business as a Foreign LLC in Your Home State
- Domesticate Your LLC
- Form a New LLC in your Home State and Dissolve the Old LLC
Let’s review these one at a time.
Register Your Business as a Foreign LLC in Your Home State
We’ve already gone over a number of reasons why this isn’t such a great idea.
But there are situations where this actually might be a smart thing to do.
Let’s take an example where you have lived in one state (Florida) for a long time, and then you decided to temporarily move to another state (North Carolina). While working in North Carolina, you are maintaining the LLC in Florida. However, during your first winter in the Carolina’s you start to miss the winters in Florida as well as the nice beaches. So you start making a plan to move back to Florida within the next several years.
In this situation, because your move is temporary, you may want to form a Foreign LLC in North Carolina and keep your Domestic LLC in Florida active. There are several reasons to do this.
First, you will be able to keep your EIN number from the Florida LLC, as well as maintain your current bank accounts. In addition, you won’t need to make any major changes with regards to your taxes or payroll since both LLC’s are being operated as one entity (even though you will be filing reports and paying fees to both states).
However, if you love the Carolina’s and decide that you are going to make the move permanent, then opening a new LLC in North Carolina and dissolving the Florida LLC would make the most sense.
Domesticating Your LLC
Domesticating your LLC means that you will basically transfer the LLC from one state to the other. This is accomplished by obtaining a Certificate of Good Standing from the original state and filing it, along with Articles of Domestication, in the new state. Once those articles are filed and approved, then you can formally dissolve the LLC in the old state.
The main reason and primary benefit to domesticating your LLC is that you will be able to keep your old EIN and bank accounts. The entire process, financially and from a tax standpoint, will be relatively painless.
However, domestication is not always an option. To domesticate your LLC, both the state you are domesticating from and the state you are domesticating to must have a procedure built into their state statutes that allows for domestication.
And, as you have probably guessed, not all states have a procedure for domestication.
So going back to the example of North Carolina and Florida above – Florida DOES allow for domestication, but North Carolina DOES NOT. This means that if you wanted to transfer your LLC from Florida to North Carolina (or vice versa), you would not be able to do so via domestication.
Form a New LLC in your Home State and Dissolve the Old LLC
The last and most cumbersome way to transfer an LLC is to simply file new Articles of Organization in your new state (presumably your home state) and dissolve the LLC in your old state.
The problem with this method is that you will need to obtain a new EIN and open up new bank accounts in the new state.
For this reason, we typically recommend timing this at the end of the year. Filing your new state Articles prior to the end of the year and making the new LLC effective as of January 1 of the new year. Then you will dissolve the old LLC as soon as you get all income and contracts transferred to the new LLC.
You will likely have to file dual tax returns for one year, but once you make it through that headache, you should have smooth sailing.
Your LLC and Taxes
I am amazed at how many people think it is a good idea to file an LLC in a state that doesn’t have an income tax because it will somehow allow them to avoid paying taxes on the earnings from their LLC.
Unfortunately, this is a myth that many companies pushing LLC’s in states like Wyoming or Nevada, where there are no state personal income taxes, would like you to believe.
The truth of the matter is that you will pay income taxes on the earnings from your LLC in the state in which you reside.
So if you live in Ohio and own an LLC in Wyoming, you will pay state, county and municipal income tax in Ohio, regardless of the fact that there is no income tax in Wyoming.
And based on what you have read so far, you likely already understand that you will need to file a foreign LLC in Ohio if that is where you are operating and transacting business. So not only will you not avoid paying income taxes in Ohio, but you will also be paying various fees related to running your LLC in Wyoming (or Nevada, or Texas, or whatever state you decide to set up your LLC in).
Which begs the question of why so many websites push LLC’s in those other states, such as Wyoming, Nevada, New Mexico and Delaware.
Let’s talk about that.
Why are Wyoming LLC’s so Popular?
Wyoming is a very popular state to form an LLC.
In part, this is because of the low filing ($100) and annual reporting fees (starting at $60).
Combine those low costs with no income tax, the ability to protect your privacy, and a favorable business environment, and it is easy to see why so many online businesses flock to form a Wyoming LLC.
But as we discussed before, if you don’t live in Wyoming, then the disadvantages to forming an LLC there and then also filing a foreign LLC in your home state, far outweigh the advantages to just setting up one LLC where you live.
The best state to form an LLC is always your home state.
But, I’m hearing you say… what about Nevada? Isn’t that the best state to set up an LLC?
Let’s discuss.
Forming an LLC in Nevada
The total state filing fees to form a Nevada LLC are $425. This includes the filing fee for your Articles of Organization ($75), the State Business License ($200) and your Initial List of Managers or Managing Members ($150). In addition, once you have filed your LLC in Nevada, you must file an annual report each year with an additional $350 fee.
Nevada is second only to Massachusetts in the overall fees required to set up an LLC.
So why do so many people flock to Nevada to set up their LLC?
According to the Nevada Secretary of State, there are a number of reasons, including: no corporate income tax, no franchise tax, “nominal” annual fees, and a business friendly court system that is based on the Delaware model.
In 2021, according to the US Census Bureau, Nevada took in over 73,000 new business applications. Since incorporating in Nevada is even more costly than filing a new LLC, we will assume that all of these applications were for LLC’s. This means that Nevada generated over $31 million dollars from new business filings alone in 2021!
And this is just for the state of Nevada alone. This doesn’t count the tens of millions of dollars earned by companies touting virtual address services, registered agent services, and filing services to set up a Nevada LLC.
Now, if you live in Nevada, then by all means, you should set up your LLC in Nevada. But if you live elsewhere, then you are much better off filing your LLC in your home state.
What about everyone’s favorite small state, Delaware?
Should You Set Up a Delaware LLC?
Delaware is a business-friendly state, and one of the most popular states to set up a new corporation. In fact, over 66% of the Fortune 500 companies have chosen to incorporate in Delaware.
This is in large part because most corporate case law was developed in the Chancery Court in Delaware. As a result, whenever there are disputes that end up in the Delaware courts, there is a large body of case law that provides certainty to how those disputes will be resolved.
Combined with a favorable business environment generally in Delaware, no sales tax, and it is no wonder that most companies choose to incorporate there.
But notice the nuance from that statement.
Companies choose to incorporate in Delaware.
These are not small entities run by one or two people, as is the case with most online businesses.
These are huge, publicly traded companies like Apple, Microsoft, Tesla, etc. that have shares and investors and lots and lots of money in the bank.
And they are NOT LLC’s.
If you are running an online business, chances are you are not at the level of Apple just yet.
But not to worry, you can set up an LLC in your home state and when you are ready to incorporate in Delaware, you can convert your LLC into a Corporation by filing Articles of Conversion, and then move your shiny new corporation to Delaware and enjoy all the benefits that come with double taxation.
If you are thinking about filing an LLC in Delaware, I would caution you. Not only will you still have to register your Delaware LLC as a foreign LLC in your home state, but you will also have to pay a registered agent in Delaware, and pay the Annual Reporting fees in both Delaware AND your home state.
In addition, if or when you realize that forming your LLC in Delaware wasn’t such a great idea, you will still have to pay your annual reporting fee ($300) plus all past due fees (and Delaware has a hefty late fee – $200 if your annual report is not filed on time each year), as well as a filing fee for a Certificate of Cancellation ($200).
That’s $700 just to cancel your Delaware LLC!
Again, if you live in Delaware, then you should file your LLC in Delaware. But if you live somewhere else, it is best to form your LLC in the state where you live.
What is the Best State to form an LLC for Online Business if I move around from state to state?
I have gotten this question from a number of clients that have scheduled strategy sessions with me.
They have an online business and live in Florida for part of the year, North Carolina for a few months, and then sometimes they travel out west to stay with friends and family in California.
So where should they file their LLC?
The answer is still the same (and I’m feeling like a broken record).
You file your LLC in your home state.
Even if you move around a lot, chances are you have a driver’s license, receive mail somewhere, are registered to vote, pay taxes, or even own property in one state. That’s the one that you have the most connection to, and the state where you should set up your LLC.
What is my Home State if I Live Overseas?
In the summer of 2022, I moved my family overseas to Portugal. So I am intimately familiar with how complicated it can be to have an LLC in the United States while you are living overseas.
Prior to our move, we lived in North Carolina. We owned property in North Carolina, were registered to vote there, registered our cars there, and sent our children to school in North Carolina.
But North Carolina has a state income tax. And even though we live overseas and therefore are no longer required to pay NC taxes, as residents we are still responsible for filing a tax return in North Carolina each year.
And frankly, that is not something that I want to do.
So in the coming months, we will be moving our domicile to Florida, where there is no state income tax. At the end of 2022, I will be moving my current businesses to Florida as well.
The only reason were are able to do this is because we will not be living in any of the 50 states.
As a result, we can choose where we want to set up our domicile.
And since my businesses will not have a physical location in the United States, other than a virtual address, then I can pick any state I want to set up an LLC.
If you have a business that will have a physical office with employees who meet with clients and transact business, then you should form your LLC in the state where your office is located.
What if I have customers all over the world in my online business?
Once again, I am amazed at how many people believe they have to form a business entity where their customers are located as opposed to where they live and work.
Where your customers are located is completely irrelevant to the decision about where you should set up your LLC.
The fact that you have a few clients that live in one state, or maybe even all of your clients live in that state, doesn’t mean that you need to set up an LLC or even a foreign LLC in that state.
Where you operate and run your business is where you should set up your LLC.
Where should I form a Real Estate LLC?
For pretty much this entire article, we have been discussing why it is best to set up your LLC in your home state if you have an online business.
But there is always an exception to the rule.
And in the case of LLC’s, that exception is when you own rental real estate investments outside of your home state.
The reason for this is that your business transactions related to your rental properties are actually occurring in the state in which you own the property.
You will pay real estate taxes in that state, you will hold a mortgage in that state (if you have financed the investment), you will have a lease that is governed by the rules of the state where the rental property is located, and you may even have a bank account in that state.
As a result, you will want to set up your LLC in the state where the rental property is located.
So What is the Best Option for Where to File My LLC for Online Business?
If it isn't abundantly clear by now, the state that will afford you the best legal protection from setting up your LLC, as well as allow you to avoid the additional fees that come from filing a Foreign LLC, is the state where you are currently living an working.
Don't overthink this decision.
Your home state is a great place to form your own LLC for your Online Business.
