Why should you form a business in Delaware? Is it worth your investment and time? Now, Delaware is one of the most preferred states in forming Limited Liability Companies (LLCs). The primary reasons for this include more affordable franchise taxes and filing fees. Plus, foreign LLCs don’t have to pay taxes for income earned out of state.
But, there are some disadvantages to incorporating in the state as well. So, before you make a move, take a look at the Delaware LLC disadvantages mentioned in this article. These downsides may help you make your decision about whether to incorporate your company in the state or not.
What Is a Delaware LLC?
A Delaware LLC is a business entity that exists apart from its owners. Thus, the managers and owners aren’t responsible for the company’s debts and liabilities. As such, roughly 64% of listed Fortune 500 businesses have chosen Delaware as their state of incorporation.
Delaware is also famous for out-of-state incorporations. It’s because the statutes and courts provide stockholders with more freedom and options. Also, it has a separate court called the Chancery Court, which adjudicates business debate, including LLC confrontation. The court has business laws established for more than 200 years.
Moreover, a Delaware LLC can also be taxed as a pass-through entity. Because of this, it is also regarded as a hybrid business structure that combines the best aspects of both LLC and C Corporation.
LLCs can be managed like legal partnerships, but they’re not corporations per se. It can have only one owner or several individuals as members or owners. There is no limit to the number of owners or members of an LLC.
The Delaware LLC Structure
Delaware LLC operates as an independent legal entity from its members. It protects owners from personal liabilities, as an LLC’s financial commitments are limited to their investments. Unlike a corporation, an LLC’s asset protection works in the opposite direction.
Charging orders protect the Delaware LLC from future judgments on individual members. A creditor who gets a judgment against a Delaware LLC member can get to the LLC’s distributions. However, a member’s creditor cannot order the LLC’s liquidation.
Delaware LLC protection is better for its members compared with those for stockholders of a corporation.
The formation of a Delaware LLC begins with the submission of a Certificate of Formation. Then, a confidential and internal Operating Agreement is made. It governs the majority of the management and ownership.
Therefore, an LLC Operating Agreement is an internal corporate law contract. Produced by the LLC’s owners, it lays out each member’s rights and responsibilities. Also, it contains the firm’s structure and how profits and losses are distributed.
Members of Delaware LLCs can customize their Operating Agreements. It is for their specific needs since Delaware doesn’t compel members to submit annual reports. An LLC in the state has only a few statutory responsibilities compared to a Delaware corporation. In general, an LLC requires far less paperwork.
Disadvantages of Filing an LLC in Delaware
When it comes to setting up a business, considering some critical things will help you succeed. As such, among the most important questions you should ask yourself are: Should you incorporate? Which state must you form your business in? And, which structure is the most compatible with your company’s objectives?
An LLC may be a new type of corporate law entity. But, many choose this to be their business structure. Now, while Delaware has distinct advantages in LLC formation, it also has some significant disadvantages. So, you should know what they are to ensure that you are making the move that is most beneficial for your business. They include the following:
It is not an exaggeration to say that forming an LLC in Delaware is much more expensive in the following situations:
There are many cases within the parent firm. Series LLC members have higher administrative expenditures. Because of accountants’ lack of familiarity with the framework, accounting charges may increase.
Your LLC will not be subject to income tax in the state of Delaware. However, it will still be subject to a Delaware franchise tax depending on the value of its shares. For small businesses, this is usually low. But, it will rise as the number of shares and the value of your stock increase. In your home state, you may also be required to pay a franchise tax.
Foreign Qualification Fees – If you have a site in the state, you have to register to conduct business there. A non-residents qualification allows a firm to operate in a state except for the one it was also formed. In other places, there may be international qualifying costs and recurring fees.
Filing fees documents, like articles of incorporation, are more expensive.
All residents of Delaware LLCs must have a state business license at the very least. Also, an operating agreement is essential for LLCs.
Delaware has the highest unemployment tax rates in the country. At the federal level, LLC members should pay significant self-employment taxes.
An annual alternative entity tax of $300 is also required. Even if you don’t receive sales taxes from consumers, you must pay a receipts tax. Workers’ compensation insurance is also needed once you hire your first employee.
Incorporating an LLC in a different state is not helpful as it needs a dual registration. Not only will you incorporate in Delaware, but you’ll also need to incorporate in your home state. That implies you’d have to produce two annual reports for your company. Also, it would be necessary to file two state tax returns. You’d also have to pay two sets of filing costs to incorporate and renew.
For tax purposes, if you formed a Delaware LLC and want to do business in a different state, you must register your company in another state as a “foreign corporation.”
But, it does not end here. In each state, you must also keep two registered agents or two attorneys.
For instance, you want to register a Delaware LLC, but you want to operate and do business in Nevada. The state filing price is $90, with a $100 annual fee for a Delaware Registered Representative. Also, the state compels all Delaware LLCs to pay a $300 “annual franchise tax”.
Also, you must pay a Foreign LLC Registration and pay the state registration fee for $120. On top of these, you also need to file a Nevada Annual Report each year for $20. Then, there is also the Business Entity Tax of $250 every other year because you are doing business in Nevada.
The Delaware Registered Tax Agent
If your LLC is also registered in a state other than Delaware, you must hire a tax-registered agent. To keep the dual registration, you’d have to keep a registered agent in Delaware. It means you’ll need someone in each state with a company address where you can reach for legal matters. Also, these registered agents are in charge of legal paperwork, which adds to the company’s costs.
Extra Reporting Documents
If your business headquarters are in another state and you incorporate in Delaware, you must follow the state’s requirements to operate there. So, you must also file annual reports in both places. And, it takes twice as long and costs twice as much to do this.
Also, you have to consider the yearly fee for registered agents and attorneys. If your company isn’t based in Delaware, you’ll have to pay a registered agent fee. These fees might cost up to $129 a year. You might also need to hire a Delaware law corporation attorney.
Even if you have a contract to handle litigation, your company must follow both states’ rules. And if a settlement is applied to the case, you’ll be keeping a Delaware LLC and one which is out-of-state. It is helpful in some circumstances, but for small entrepreneurs, the difficulties may result in increased expenses and potential dangers. Thus, it puts your company at a disadvantage.
Difficulty in Obtaining Separate Identification Numbers
Another con of the Delaware LLC structure is obtaining a different ID number. It’s pretty tough and challenging. The incorporated company might be unable to get unique ID numbers. For federal tax reasons, the structure of a Delaware LLC can be unique if the series option is selected. Each series is considered a separate LLC. Persons in charge of it must need their federal tax identification number, which can be hard to get.
No Tested Business Structure
The benefit of forming an LLC in Delaware is exceptional. But it is a two-edged sword. Series LLCs have their drawbacks.
When deciding to form a series LLC or a standard LLC in Delaware, the business’s distinctive structure has all been tested. Most courts will likely dismiss each series’ independent assets, records, and liabilities. They’d dismiss the formal division, and consider the total umbrella LLC as the main business.
No Real Tax Savings for Small Businesses
Though Delaware doesn’t tax incorporated businesses in the state where they don’t operate, your home state will still tax your business. So, at the end of the day, you’ll still have to pay taxes.
Legal Disputes and Traveling
Any legal conflicts affecting your business must be all reviewed in Delaware. You will have to go to Delaware to have them sorted and resolved. You will also need to hire a Delaware attorney rather than use the one you have in your home state to take care of the matter.
For instance, you are conducting business without authority. This is when your LLC has not registered in that state wherein you are operating your business. You must file an application for authority for a foreign LLC. That means you have to go to that specific state to comply with all the requirements needed. And, that means more expenses for you and your company.
Precipitate Foreign Qualification Fees
Operating a business outside your home state can trigger a foreign qualification. You will have to contact your home state to know what formation documents are needed from Delaware. The time for applying for this qualification can reach ten business days. It can also extend the startup for your company.
Also, you must register your firm as a foreign C corporation where you operate. “Foreign Qualification” is another name for this procedure. The Qualification Certificate has a filing cost of $245. You’ll get a stamped version and a Secretary of State Certificate of Qualification. For an extra $50, you can get expedited services for getting a certified copy.
An LLC’s ownership is often more difficult to transfer than that of a C corporation. Firms could sell shares of stock to increase ownership. And also, stockholders could sell their shares to someone else. This can happen unless there is an agreement to the contrary. Except if it’s stated in the operating contract, all members of a limited liability company must allow adding members.
Despite many drawbacks, there are benefits when you incorporate your businesses in Delaware. Consult the experts from Doola when you need help.
“Visit the official website of Delaware to learn more about the required legal documents that should be filed when incorporating a business in the state.”
LLC in Delaware: Should You Push Through
The advantages of a Delaware LLC may be significant for investors all over the world. But, it would be best if you also addressed some of its disadvantages. Discuss all of these issues with experts before going through the process of incorporation. This is where Doola comes in. It is a trusted and reliable partner when it comes to incorporation. Contact them at +1 (551) 273-2773 or email them at firstname.lastname@example.org.
Delaware LLC Disadvantages FAQs
Does Delaware LLC pay taxes?
Delaware LLC doesn’t pay taxes as Delaware LLC treats each member of a disregarded entity as a sole proprietorship for tax matters.
What is the Delaware tax loophole?
The accounting approach allows large firms to report certain income in the state where they are incorporated instead of where the money is produced.
Is it worthy to incorporate in Delaware?
Incorporating in Delaware is worth it, but only for large corporations. However, it’s a waste of time and money for small businesses to incorporate in the state since it is expensive and has limited benefits.
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