A common misconception about forming a corporation is that it must be formed in the state where the primary place of business will be physically located. While incorporation in that state probably makes the most sense for corporations that do business only in one state, a corporation may be formed in any of the 50 states or the District of Columbia, regardless of whether the corporation has, or will have, any physical presence or conduct any business activities in that state.

Considerations in Choosing a State of Incorporation

The factors most often considered in choosing the state of incorporation are:

• the location of the corporation's physical facilities and business operations;
• the relative costs of forming and maintaining the corporation; and,
• the relative advantages and disadvantages of each state's corporate and tax laws.

While a corporation may be formed in any state regardless of whether it has a physical or business presence in that state, it generally will be required to qualify to do business as a "foreign corporation" in any state in which it does business other than its state of incorporation. Therefore, the cost of qualifying to do business in the other state(s) must be factored into the cost of incorporating.

Selection of the state in which to incorporate must go beyond an analysis of the state's administrative and tax costs. The selection process also must include an analysis of practical considerations and costs. Such considerations may include the necessity of employing a registered agent in the state of incorporation for the purpose of service of process if the corporation will not maintain a physical presence in that state, and possible requirements that board meetings or annual meetings be held in that state or that the records of the corporation be kept in that state.

In addition to the financial costs of incorporating in a particular state, the corporate law and court system of the potential state of incorporation must be analyzed to determine whether any additional financial costs of incorporating in that state may be outweighed by the benefits of incorporating there. When evaluating the relative tax consequences of incorporation in a particular state, keep in mind that the absence of a corporate income tax in the state of incorporation does not mean that income earned from business conducted in other states will not be subject to taxation by the states in which the business was conducted. Also, don't overlook the fact that the absence of a corporate income tax in the state of incorporation means that there will be no credits to apply to the corporation's profits derived from its business activities in other states. Therefore, the tax savings may be smaller than initially appears.

While incorporation in another state may be beneficial, for most corporations that will be doing a majority of business in one state, incorporating in that state generally will make the most sense.

Advantages of Selected States

Delaware

For years large corporations have chosen Delaware as their state of incorporation. The most often cited advantages to incorporation in Delaware include:

• a well developed and business friendly body of corporate law;
• low cost of incorporation;
• corporate friendly income tax laws and lenient disclosure requirements;
• no requirement to disclose the names or addresses of the initial directors; and,
• the Delaware Court of Chancery (a court dedicated primarily to hearing complex business matters).

Today, many of the advantages of incorporating in Delaware over other states, including North Carolina, are less pronounced than they once were due to developments in the corporate laws, the establishment of business courts (such as the North Carolina Business Court), and a reduction in the cost of incorporation in many states.

Nevada

Recently, Nevada has become a popular state of incorporation. According to the Nevada Secretary of State's office, some of the advantages of incorporating in Nevada are:

• shareholders may remain anonymous because shareholder names are not required to be made part of the public record;
• directors, officers, and shareholders may be nonresidents of Nevada;
• no state income tax on corporate profits;
• no annual franchise tax; and,
• one person is permitted to hold all offices of the corporation.

The Corporation's "Home" State

As previously mentioned, for most small– and medium–sized corporations, it likely will make the most sense to incorporate in the state where the physical facilities or the majority of the corporation's business is located. Some of the advantages of incorporating in the "home" state include:

• familiarity of the corporation's local counsel with applicable state law:
• convenience of geographical proximity to courts and governmental services; and,
• no need to register as a foreign corporation (if all business is done within the state of incorporation).

Conclusion

For small– and medium-sized corporations that will be conducting business primarily in only one state, the most logical state of incorporation is usually the state in which the majority of the business will be conducted or in which their facilities are located. If the nature or circumstances of the business are such that the privacy or protections afforded by another state's laws are desirable, the additional administrative and financial costs of incorporating in the other state may be worthwhile. When choosing a state of incorporation, it is important to consult with your legal and tax advisors to determine the relative advantages and disadvantages of incorporation in different states. The choice can have significant legal and financial consequences down the road.

For further information regarding the issues described above, please contact John P. Crolle.

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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.