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Starting a business is an exciting step, but choosing the right legal structure can be daunting. We are often asked by clients about what entity they should choose, a corporation or an LLC (limited liability company) as well as whether or why to incorporate in another state, such as Delaware or Nevada.

In this article, we will explore and explain the different options. By looking at the differences, as well as compliance, costs and tax implications, taxation, we hope you will be able to reach your own conclusion.

Of course you understand this is general information and is not be taken as specific legal or tax advice. For your circumstances, consult with a licensed attorney and or tax professional.

1. Overview of Business Entities

a) Sole Proprietorship

• Liability: Unlimited personal liability.
• Taxes: Profits reported on personal returns and subject to self-employment taxes.
• Compliance: Minimal setup but high risk.

b) Partnership

• Types:
  • General Partnership (GP): Unlimited liability for all partners.
  • Limited Partnership (LP): Liability for limited partners restricted to their investment.
  • Limited Liability Partnership (LLP): Partners enjoy limited liability, commonly used in professional practices.
• Taxes: Pass-through taxation with partners reporting profits on personal returns.

c) LLC

• Liability: Limited liability protection.
• Taxes:
  • Pass-through taxation by default.
  • Self-employment taxes on all profits unless S Corp election is made.
• Compliance:
  • Operating Agreement: Governs the relationship between members and management. Although not required by law, it is highly recommended.
  • Annual Statement of Information Filing: $20 annually in California.
  • Franchise Tax: $800 minimum, regardless of revenue.
  • Gross Receipts Fee: for revenues over $250,000.

d) C Corporation

• Liability: Owners’ personal assets protected.
• Taxes:
  • Corporate income taxed at 21% (federal) and 8.84% (California).
  • Dividends taxed at shareholder level (15%+).
• Compliance:
  • Corporate Bylaws: Required to outline internal governance.
  • Stock Issuance and Records: Maintain detailed records of stockholders.
  • Corporate Meetings: Must hold annual shareholder and director meetings; minutes must be documented.
  • Statement of Information Filing: $25 annually.
  • Franchise Tax: $800 minimum.

e) S Corporation

• Liability: Same as C Corps.
• Taxes:
  • Pass-through taxation.
  • Salaries subject to payroll taxes (15.3%), but distributions avoid self-employment taxes.
• Compliance: Limited to 100 shareholders, one class of stock, and requires filing Form 2553 with the IRS.

2. Financial Impact of Different Entities at Different Revenue Levels

It will be very helpful to look at the financial and tax obligations of different business entities at various revenue levels to understand how the choice of entity impacts your bottom line.

The tables below provide a comparison of LLCs, C Corporations, and S Corporations at revenue levels, where tax implications and compliance costs shift significantly given that

• LLCs: Subject to California’s gross receipts fee starting at $250,000 revenue. Additionally, LLC owners must pay self-employment taxes on all net income.
• C Corporations: Face double taxation on corporate income and dividends, but profits retained within the corporation avoid the second layer of taxation.
• S Corporations: Provide a tax-efficient structure, as owners pay payroll taxes only on reasonable salaries, with distributions exempt from self-employment taxes.

LLC

Revenue	Franchise Tax	Gross Receipts Fee	Self-Employment Tax (15.3%)	Total Cost
$100,000	$800	$0	$15,300	$16,100
$250,000	$800	$900	$38,250	$39,950
$500,000	$800	$2,500	$76,500	$79,800
$1,000,000	$800	$6,000	$153,000	$159,800
$5,000,000	$800	$11,790	$765,000	$777,590

Notes:

• Self-employment tax applies to all net income unless the LLC elects S Corp status.
• Gross Receipts Fee increases significantly at higher revenue levels, adding substantial costs at $1 million+ revenues.
• LLCs are ideal for small businesses with modest revenues due to their simplicity, but their tax burden grows with revenue.

C Corporation

Revenue	Federal Tax (21%)	State Tax (8.84%)	Dividend Tax (15%)	Total Cost
$100,000	$21,000	$8,840	$10,524	$40,364
$250,000	$52,500	$22,100	$26,910	$101,510
$500,000	$105,000	$44,200	$53,580	$202,780
$1,000,000	$210,000	$88,400	$107,460	$405,860
$5,000,000	$1,050,000	$442,000	$537,900	$2,029,900

Notes:

• Double taxation applies to distributed profits, with corporate income taxed at the federal and state levels and dividends taxed at the shareholder level.
• Retaining earnings in the corporation defers dividend tax but does not avoid corporate tax.
• C Corps are advantageous for businesses reinvesting profits or planning for significant growth and external investment.

S Corporation

Revenue	Salary (50%)	Payroll Tax (15.3%)	State Tax (1.5%)	Total Cost
$100,000	$50,000	$7,650	$750	$9,200
$250,000	$125,000	$19,125	$1,875	$21,000
$500,000	$250,000	$38,250	$3,750	$42,000
$1,000,000	$500,000	$76,500	$7,500	$84,000
$5,000,000	$2,500,000	$382,500	$37,500	$420,000

Notes:

• S Corps allow owners to split income between salaries (subject to payroll taxes) and distributions, minimizing self-employment tax exposure.
• The 1.5% California state tax applies to net income.
• S Corps are ideal for small-to-medium businesses seeking tax efficiency with corporate liability protections.

3. Should You Choose an LLC or a Corporation?

For startups, the two main options are an LLC or a corporation (often a C-Corp or S-Corp). Here’s a breakdown:

Structure	Best For	Advantages	Drawbacks
LLC	Small businesses, startups without investors	Flexibility, fewer regulations	Can be harder to attract investors
C-Corp	Startups seeking outside funding	Preferred by VCs, potential for stock options	Double taxation (but strategies can minimize this)
S-Corp	Small businesses with few shareholders	Avoids double taxation	Restrictions on the number of shareholders

4. Out-of-State Formation: Delaware, Nevada, and Wyoming?

For businesses considering out-of-state incorporation, Delaware, Nevada, and Wyoming are often seen as favorable jurisdictions due to their tax structures, privacy protections, and legal advantages. However, operating in California comes with additional compliance and tax obligations, which must be carefully evaluated when choosing a formation strategy.

Delaware: Key Advantages

Delaware is widely regarded as the gold standard for corporate formation, particularly for businesses seeking to raise capital or go public. Over 60% of Fortune 500 companies are incorporated in Delaware.

• Corporate-Friendly Laws: Delaware’s Court of Chancery is an established business court, known for consistent rulings in corporate cases, providing efficient and predictable resolutions.
• Favorable for Fundraising: Investors often prefer Delaware corporations due to the state’s robust legal framework.
• Flexible Corporate Structures: Allows multiple classes of stock, critical for venture capital and IPO readiness.
• Privacy: Delaware allows businesses to keep owner information private.

Franchise Tax System

Delaware’s franchise tax can be calculated using two methods, each with distinct financial implications:

1. Authorized Shares Method:
   • $175 for up to 5,000 shares.
   • $250 for 5,001–10,000 shares.
   • $85 for each additional 10,000 shares.
   • Maximum Tax: $200,000.
2. Assumed Par Value Capital Method:
   • Calculated based on the value of gross assets divided by issued shares.
   • Minimum Tax: $400.
   • Maximum Tax: $200,000.

Example:
A corporation with 1,000,000 authorized shares might pay $8,675 under the Authorized Shares Method. However, if gross assets and issued shares align favorably, the Assumed Par Value Method could lower this to $400.

Corporate Income Tax

• Rate: 8.7% on Delaware-sourced income.
• Only applies to income derived from business operations within Delaware, making this tax less relevant for companies operating primarily in California.

b) Nevada: A Privacy-Friendly State

Nevada appeals to businesses prioritizing privacy and low taxation.

Tax and Fee Structure

• Annual Business License Fee: $500.
• No Franchise Tax: Beyond the business license fee, Nevada does not impose a traditional franchise tax.
• No State Corporate Income Tax: Unlike Delaware, Nevada does not tax corporate income at the state level.

Key Advantages of Nevada:

• Privacy Protections: Nevada does not require the disclosure of ownership details in public records, offering enhanced privacy.
• No Tax on Corporate Income: A significant advantage for companies generating profits out of state.

Drawbacks:

• Limited Legal Precedent: Nevada lacks the extensive corporate case law that Delaware offers.
• Higher Initial and Ongoing Fees: The $500 annual business license fee exceeds both Delaware’s minimum franchise tax and Wyoming’s reporting fees.

c) Wyoming: The Low-Cost Leader

Wyoming is an attractive option for small businesses seeking simplicity and cost savings.

Tax and Fee Structure

• Annual Report Fee: $60, based on the company’s assets located within Wyoming.
• No Franchise Tax: Similar to Nevada, Wyoming does not impose a traditional franchise tax.
• No State Corporate Income Tax: Like Nevada, there is no corporate income tax.

Key Advantages of Wyoming:

• Low Costs: Annual fees are among the lowest in the U.S.
• Asset Protection: Strong legal protections for LLCs and corporations.
• Privacy: Offers similar confidentiality benefits to Nevada.

Drawbacks:

• Less Recognized for Capital Raising: Wyoming’s legal framework is less established for companies seeking significant venture capital or public offerings.
• Less Developed Legal System: Fewer corporate cases and specialized courts compared to Delaware.

d) Comparison of Out-of-State Costs

State	Franchise/Business Tax	Other Annual Fees	Corporate Income Tax
Delaware	$175–$200,000	$400 minimum (if low shares)	8.7% on Delaware-sourced income
Nevada	None	$500 Business License	None
Wyoming	None	$60 Annual Report	None

e) California’s Overlay for Out-of-State Entities

Even if you form your entity in Delaware, Nevada, or Wyoming, you will still face California’s foreign entity registration requirements if you operate or derive significant revenue from the state.

California Requirements for Foreign Entities:

• Franchise Tax: $800 minimum annually, regardless of the state of formation.
• Compliance Requirements: Foreign entities must file and comply with California’s reporting and tax obligations.
• Operating in California: If your business has a physical presence, employees, or generates income in California, you are subject to California’s corporate tax and compliance regime.

f) Practical Considerations: Forming in California vs. Out-of-State

When to Choose California:

• Local Focus: If your business operates exclusively in California, forming in-state simplifies compliance.
• Lower Complexity: Avoid dual compliance and additional registration costs.

When to Choose Delaware:

• Scalability: For businesses planning to raise capital, issue multiple stock classes, or go public, Delaware’s legal system and investor familiarity provide significant advantages.
• Legal Certainty: Delaware’s Chancery Court offers a well-established body of corporate law.

When to Choose Nevada or Wyoming:

• Cost and Privacy: Small to medium-sized businesses seeking low fees and privacy might benefit from these states.
• No State Corporate Tax: If your business operates across states but outside of California, these states offer tax advantages.

California: Key Advantages

• Local Operations: If your primary operations are in California, local incorporation can reduce administrative hassle.
• Access to Talent and Resources: California’s economy, especially in tech, offers a robust talent pool and resources.

Comparison Table: Delaware vs. California

Factor	Delaware	California
Legal Protections	Business Court (Court of Chancery)	General legal system
Privacy	High	Moderate
Taxes	No state corporate income tax	State taxes apply
Ease of Attracting Investors	High	Moderate to High (depending on industry)

5. Conclusion

Choosing the right entity involves weighing liability protections, tax efficiency, and growth potential. Each entity type offers distinct advantages depending on your business’s size, revenue, and long-term goals. Out-of-state formation in Delaware, Nevada, or Wyoming may offer strategic benefits but must be evaluated against California’s tax and compliance requirements.

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6. FAQs About Startup Incorporation

Here are answers to some of the most common questions about incorporating your startup:

What’s the Difference Between an LLC and a Corporation?

An LLC is a more flexible structure, with simpler tax requirements and fewer regulations, while a corporation is often better suited for startups seeking investors.

Why Do So Many Companies Incorporate in Delaware?

Delaware’s business-friendly laws, privacy policies, and experienced court system make it an attractive option for larger businesses.

When is the Best Time to Incorporate?

It depends on your business’s growth stage, funding needs, and liability exposure. Generally, startups secure incorporation before raising funds or hiring employees.

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Additional Resources:

• Business Startup Checklist
• Key Terms to Include in a Founder’s Agreement
• Penn Law Startup Kit: Founder’s Agreement