LLC Formation: Which State Is Best?

Feb 25, 2022 10:00:00 AM

  

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When your client starts a limited liability company (LLC), they are not confined to forming it in their home state. Because all fifty states allow “foreign LLCs” to operate within their borders, your client can shop around for the state with the most advantageous rules. Your client can then operate the LLC under the law of the state where it was formed. Keep reading to discover the best states to form an LLC.

What to Look for in an LLC Formation State

Before embarking on this nationwide tour, you should consider the types of advantages your client is looking for. Of course, the most important factor is liability protection, since the purpose of an LLC is to safeguard the client’s personal assets. Also helpful is a state that allows substantial freedom of contract, in which the terms of an LLC operating agreement apply if they do not contradict provisions of the state statute that are expressly made mandatory. For example, according to Colorado’s LLC statute, an LLC cannot

  • eliminate obligations of good faith and fair dealing,
  • restrict members’ rights to records and confidential information, or
  • modify the timeline for voluntary dissolution.

You can also help your client form their LLC in a state that protects the durability of the LLC’s existence. The grounds for judicial dissolution of the LLC are stricter in some states than in others. For example, the California statute allows complaining LLC members to seek dissolution of the company if it is reasonably necessary to protect their rights and interests, while Delaware law focuses instead on whether it is reasonably practicable for the company to continue to operate according to its operating agreement.

Also, your client will likely want to form the LLC in a state with low fees and corporate taxes. In addition, your client may want to consider whether a state requires annual reports and minutes. Finally, while some states require new business owners to wade through substantial red tape, other states allow them to take care of everything easily online. 

In no particular order, the following three states are generally considered to have favorable LLC statutes: 

1. Nevada

The Silver State is very hands-off, as it does not impose corporate, personal, or franchise taxes. LLCs are not required to report on annual meetings or have an operating agreement (though an operating agreement is highly recommended). Some business owners also appreciate the fact that Nevada does not have an information-sharing arrangement with the Internal Revenue Service. Regarding veil-piercing, Nevada has adopted the alter ego test; it focuses on whether separation of the owner from the LLC would perpetuate a fraud or manifest injustice. Anyone who sues an LLC is not required to prove that the company was a sham at its inception.

2. Delaware

Many people believe that few states are more business-friendly than Delaware, as the First State proudly hosts sixty-eight percent of Fortune 500 companies. Delaware has low fees and a simple filing process. Business disputes are settled in a special Chancery Court, whose judges have business expertise. Delaware also offers privacy by not requiring the publication of LLC member names. Delaware does not have a well-defined statute regarding veil piercing; its courts have focused on fraud and have adopted the alter ego test. The courts consider several factors in determining whether to pierce the veil, including whether the LLC has sufficient capital, company records, and other formalities.

3. Wyoming

Like Nevada, Wyoming does not have personal or corporate taxes, nor does it impose reporting obligations. Your client does not need to visit the Equality State to set up the LLC, and the appointment of a lifetime proxy allows the owner to maintain anonymity. The LLC does not have to provide the state with members’ names. Wyoming was the first state to develop LLC laws, and its legislature is quick to amend its laws to ensure that businesses receive strong protection. Creditors have a difficult time piercing the entity veil in Wyoming. Wyoming’s statute provides that certain factors must be present to pierce the veil, and except for fraud, more than one factor must exist to impose liability. 

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