There’s a lot of noise on the Internet when it comes to figuring out whether or not to form your limited liability company (LLC) in Delaware.
I should know.
Over the past decade of living in California, I’ve operated multiple sole proprietorships. And at the exasperation of both my accountant and lawyer, I’ve also owned both a California and a Delaware LLC. (Whoops!) I’ve experienced first-hand the pros and cons of forming a Delaware LLC while living in California.
Need help with Delaware state tax registration for your business? Our partners at CorpNet can help.
So, I had no choice but to get to the bottom of this question. I did a lot of research. I read the laws, flipped through the history books, and interviewed attorneys and tax professionals who work specifically with LLC owners.
This article is packed with resources you need to answer this question. I also included a number of additional things to consider when you’re deciding how to incorporate your business. So let’s dive in.
What is an LLC?
An LLC is a type of business structure where, as an owner (referred to as a member), you’re not personally responsible for the debts of the business.
The key benefits of an LLC include:
Helps you avoid double taxation (in most states)
Protects your personal assets from lawsuits and creditors
Compared to a sole proprietorship, the other common business entity for a one-person business is a single-member LLC, which provides some asset and liability protection. (A multi-member LLC is when you partner with others.) A single-member LLC does not leave you personally responsible for the debts your business incurs. It also provides additional tax and legal benefits beyond what you get as a sole proprietor.
How to create an LLC in Delaware
If you’re ready to start a business in the Diamond State, here’s how to go about it.
Choose your business name
When choosing a name for your new LLC, make sure to follow the state’s LLC naming guidelines. For instance, you should include the term “Limited Liability Company,” “LLC,” or “L.L.C.” in it. You can find further information on Delaware’s LLC naming guidelines here.
You’ll also need to confirm that your desired business name hasn’t already been taken by another business or entity operating in Delaware. Check the availability of your business name on the Delaware Division of Corporations website.
Designate a registered agent
A registered agent receives tax documents, legal notices, and other official correspondence on behalf of your business. The state requires you to appoint an agent who has a physical address in Delaware and is available during regular business hours. You’ll also need to maintain this requirement for as long as your business is in operation.
You can act as your company’s own registered agent if you have an address in Delaware, or you can hire a professional registered agent service. Explore some options for Delaware registered agents here.
File a Certificate of Formation
Compared with other states, Delaware requires a minimal amount of information to form an LLC. The business formation documents (called the Certificate of Formation or Articles of Organization, which are filed and approved by the Delaware Secretary of State) don’t require your personal information, which means your identity is not made public.
It does, however, require a $110 filing fee that’s paid to the Division of Corporations. (You can pay for expedited services and get an LLC formed on the same day by paying additional fees. Here’s the fee schedule.)
This is the information you’ll need to include on your Certificate of Formation:
Your Delaware LLC name
Your registered office street address
Duration of LLC (only if you have a predetermined dissolution date)
Date of formation
The name and physical address of your registered Delaware agent for service of process to accept legal documents
Name and signature of the person authorized to form the LLC
This is what the certificate looks like:
Your name will appear under the ‘Authorized Person’ section if you complete the Certificate of Formation yourself.
That is, unless you want to take advantage of the anonymity offered by the Delaware Limited Liability Company Act. If that’s the case, you’ll need to hire a Delaware-registered agent who can prepare the Certificate of Formation for you.
Your registered agent’s name will be listed as the authorized person. In fact, you don’t even need a US business bank account to register this way, which means the ownership of the company is shielded.
You can use the incorporation services of a registered agent service like Gusto’s partner CorpNet to file a Certificate of Formation for your Delaware LLC.
Create an operating agreement for your LLC
You don’t necessarily need an LLC operating agreement while filing for the Certificate of Formation in Delaware. It’s simply an internal document meant to guide an LLC’s members.
However, to avoid conflicts in the future, lawyers often recommend that business owners spell out the ownership and operating procedures of their LLC through an official agreement.
When creating your LLC’s operating agreement, consider including the following information:
Member ownership percentages
Rights and responsibilities of members and managers (if any)
Profit and loss allocations and distributions
Processes for admitting and removing members
Voting rights
Ownership transition processes
Apply for an EIN
Next, you’ll need a federal employer identification number (or EIN for short) from the Internal Revenue Service (IRS). This nine-digit number is used to identify your business on tax returns and other official documents. You’ll also need it to open a business bank account, apply for a loan, and hire employees.
Apply for an EIN for free on the IRS website.
Apply for local business licenses and permits
All businesses must apply for a general business license with Delaware’s Division of Revenue before they can operate within the state.
Depending on your LLC’s location and your business activities, you may be required to apply for additional local and industry-specific licenses or permits. For example, if you plan on hiring employees within the state, you’ll need to register for payroll taxes.
Maintain your LLC’s ongoing requirements
LLCs in Delaware are not required to file annual reports with state authorities detailing the activities of the prior year. You do need to renew your business license annually, however.
You’ll also have to pay a $300 franchise tax on or before June 1 every year through the Delaware Division of Corporations website.
Why do so many businesses choose to form an LLC in Delaware?
As per the Delaware Division of Corporations, more than a million businesses, including more than 66% of the Fortune 500s, have chosen this tiny state as their home.
Numerous high-profile companies (including the likes of Google and Coca-Cola) are incorporated in Delaware because of its business-friendly laws and policies, tax system, and corporation court (which we’ll get into here).
Delaware was the first US state to vote in favor of the Constitution, and it was also one of the first states to adopt a General Corporation Law. Almost every edition of a survey (except for 2017) by the US Chamber Institute for Legal Reform (ILR) has declared Delaware as having the most business-friendly legal climate.
Delaware’s Court of Chancery
Delaware continues to offer one unique legal advantage to businesses through its Court of Chancery. The Delaware Court of Chancery is a trial court that dates back to 1792, and doesn’t have a jury.
Delaware’s Court of Chancery has a history of being an exclusive equity legal system that handles only lawsuits and petitions requesting remedies in the form of injunctions or court orders, rather than damages. The judges who rule on cases are called chancellors and are well-versed in corporate law.
Here’s why we’re telling you this.
The Court of Chancery makes it easy to deal with legal disputes as the owner of a Delaware LLC.
It can take up to a couple of years, if not more, for a civil trial to resolve in the US. But if you’re a Delaware-based company, you can expect a resolution for your business dispute in weeks.
You can even expedite appeals to the Delaware Supreme Court. (Just know that you’ll need to be physically present in the state for any court dates.)
In most state civil courts, corporate cases are pushed to the bottom of the backlog. Additionally, in most states, juries are tasked with passing judgment on business decisions without insight into the inner workings of companies. This means that judges and lawyers need to study corporate law for every trial, which adds unpredictability and delays to corporate cases.
As more businesses incorporate in Delaware, it leads to an increase in corporate trials. Therefore, the state now has a large body of case law to help business owners figure out how to handle legal issues.
How would you like to know beforehand if your business should fight a corporate lawsuit or settle? The case law will help you and your lawyer decide.
With a large number of precedents to draw from, incorporation in the state may be a smart move if you expect to deal with litigation. You can use the consistency of law and speed of resolution to your advantage.
Tax Exemptions in Delaware and the “Delaware Loophole”
Delaware is viewed as a domestic tax haven. This is no surprise because the tax laws of the state give business owners many ways to lower their tax bills.
Let us count the ways:
You don’t need to pay income tax if your company operates outside Delaware.
Your in-state purchases are not subject to taxation because there is no sales tax in Delaware, irrespective of whether you are physically located in the state or not.
Delaware doesn’t impose a property tax, so you can own office space by simply paying county-level real estate tax (which is relatively low).
The state doesn’t levy fees for value-added taxes (VAT), inheritance tax, or inventory tax.
Lastly, the “Delaware Loophole.” Delaware doesn’t tax the gains from fixed-income or equity investments. This has led to corporations establishing shell companies in Delaware (known as Delaware holding companies) and collecting income from intangible assets, like patents, for example.
The Delaware Loophole helps companies avoid tax liabilities in other states by moving parts of their businesses (including trademarks, copyrights, patents, and investments) to Delaware.
Naturally, these tax advantages are more appealing to large companies, not your average small business owner.
Delaware holding companies can collect income from intangible assets like patents and trademarks without paying any taxes on that income. Then, the parent companies usually pay a royalty to their Delaware subsidiaries to lease back these assets.
In the states where these companies actually conduct business, these royalties result in income tax deductions. Even more, these shell companies can funnel tax-free profit back to their parent companies through dividends and loans.
A famous case of the Delaware Loophole
One creative case that got a lot of scrutiny for this practice came from Toys “R” Us. (It even attracted a lawsuit.)
The company paid a Delaware subsidiary to place the business name Toys “R” Us on its retail stores. It then deducted the money it paid to its Delaware subsidiary from its in-state earnings in other states, which reduced its tax burdens there.
At the end of the day, it was obvious that Toys “R” Us was moving money from other states to Delaware, where, because their trademark is an “intangible asset” in that state, it isn’t actually taxed. The company ultimately lost the lawsuit in one state, but was allowed to continue using this practice in the other states in which it operated.
Advantages and disadvantages of creating an LLC in Delaware
Some of the biggest advantages of creating an LLC in Delaware include:
Privacy: Delaware is just one of four states that allow LLCs to keep their ownership information anonymous and private while still receiving all the same treatment and benefits as any other LLC.
Legal action: The Delaware Court of Chancery enables Delaware-based companies to get legal disputes addressed quickly and expertly by judges who specialize in corporate law, without involving juries.
Tax savings: The state imposes zero sales tax, and it allows profits from intangible assets like trademarks, naming rights, or other intellectual property to go untaxed in the state. If you originally formed your LLC in a different state, you also don’t pay taxes on the income you generate in Delaware.
On the other hand, below are some of the drawbacks of creating an LLC in Delaware—particularly if you’re a business owner from out of state:
Annual franchise tax: LLCs formed in Delaware pay a $300 franchise tax every year. Although it’s not the highest franchise tax levied by the state, some states don’t assess a franchise tax at all.
Dual registration: Delaware’s unique tax environment is one that’s highly sought after by business owners. However, registering your LLC in two states can put a lot of financial and administrative stress on your business operations.
Corporation-focused tax benefits: Most small businesses don’t make enough money to take full advantage of the tax benefits that the state has to offer. So if you’re planning on registering your business as a foreign entity in Delaware specifically for the tax benefits, you may want to consult a tax professional first.
So, should I form a Delaware LLC?
If you live outside of Delaware, then my answer would be no—forming a Delaware LLC would probably not be the best decision. Based on my research, my opinion is that it’s generally best to form your LLC in your home state.
That extra step of registering as a foreign entity costs valuable time and additional filing fees—both upfront and on an ongoing basis. This is because your LLC technically continues to operate in your home state and Delaware, where it’s registered.
While Delaware does indeed have one of the most business-friendly legal systems in the country and no taxes on out-of-state corporate income, the additional complexity and filing requirements that come with operating a Delaware LLC when living and doing business in another state aren’t worthwhile in my view.
Of course, if you live in Delaware, these considerations won’t apply to you and your new business. With all of the advantages of a Delaware LLC and none of the downsides of registering as a foreign entity, you’ve got a lot working in your favor.
For more information on starting a small business, check out our blog.
FAQs about creating an LLC in Delaware
Below are answers to a few popular questions about registering an LLC in the state of Delaware.
Do I need to live in Delaware to form an LLC there?
No, you don’t need to live in Delaware to form an LLC in the state. You can do so as long as you meet the business formation and ongoing requirements enacted by the state.
How much does it cost to start an LLC in Delaware?
You can expect to pay the following state fees and taxes when you start an LLC in Delaware:
Certificate of Formation filing fee: $110
Delaware business license: depends on your industry, but typically $75
Registered agent (optional): depends on whether you work with a service provider
Name reservation fee (optional): $75
Annual franchise tax: $300
Can I write off losses and expenses on a Delaware LLC in the same way as a corporation?
Unlike a Delaware corporation, which is taxed as a business entity, a Delaware LLC works as a pass-through entity for tax purposes. This means that profits flow through to owners without the LLC directly paying federal tax to the Internal Revenue Service (IRS). They are taxed under the individual income tax, rather than being subject to a corporate tax, and any losses can also be claimed on the owner’s personal income tax returns.
You can also include startup costs under the qualifying expenses of the business during the first year.
Is an LLC the right choice for my startup?
If your startup plans to raise capital and go public in the future, then an LLC is probably not the right fit. You may want to consider taking the C corporation route, which still allows you to protect your assets from creditor claims.
However, it creates a complex taxation structure because your business is first taxed at the corporate level when the company makes profits. Further, the owners (called shareholders) are taxed again when the profit dividends are given.
You can get over the double taxation in a corporation by filing for S corporation status, but that entity limits you to 100 shareholders—though that’s only a problem if you plan on offering equity to a large number of employees or investors.
Are there any cases where registering a Delaware LLC is better than forming an LLC in your home state?
It’s usually best to form your LLC in your home state for the vast majority of people and use cases, since that’s where you’re legally doing business. Forming an LLC in a different state from your own usually ends up costing much more and creating more filing requirements in the long run.
There are two exceptions to consider:
Non-US residents can choose to form an LLC in any state.
Real estate investors sometimes form a parent LLC in Wyoming. The Wyoming LLC then owns a child LLC that’s set up in the state where the property is..
Ultimately, however, registering your business in a state other than your home state results in additional fees and filing requirements, which means it’s unnecessarily burdensome for the majority of business owners and situations.
