Choosing a State for LLC Incorporation

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I have spent a fair amount of time recently trying to figure out which state makes the most sense to form an LLC. People say great things about DE, WY, and NV. Mainly in regards to purported tax or privacy advantages. When forming an LLC to hold real estate it often makes the most sense to incorporate in the state that you own the property. Most of the time if your LLC is in another state you will need to register it as a foreign entity (or form a new LLC), because you are transacting business in that state. If you do not have an LLC registered in a state where you are transacting business you could face penalties. These are different depending on the state, but generally amount to:

  - No legal standing, so you can not file lawsuits

  - Prohibited from continuing operations 

  - Forced to pay fines, penalties, and back taxes.

As note investors, we can usually get away with operating a note business without it being considered 'transacting business'. That's kind of a wishy-washy term, and most states do not specifically define what that means in relation to foreign registrations, but there is usually a list of exclusions. For example, the Colorado Revised Statutes list the following activities as not considered to be transacting business:

(a) Maintaining bank accounts;

(b) Maintaining offices or agencies for the transfer, exchange, and registration of its own securities or owner's interests, or maintaining trustees or depositories with respect to those securities or owner's interests;

(c) Creating, as borrower or lender, or acquiring, indebtedness;

(d) Creating, as borrower or lender, or acquiring, mortgages or other security interests in real or personal property;

(e) Securing or collecting debts in its own behalf or enforcing mortgages or security interests in property securing such debts;

(f) Owning, without more, real or personal property;

So, we typically have more options available to us, similar to people who run online businesses. This brings me to a discussion about which state makes the most sense. I have heard that there are tax advantages to incorporating an LLC in other states (NV is billed as a tax haven). And this might be true for certain entities, but for an LLC that is being taxed as a sole proprietorship or partnership I don't see how it makes much difference. The income still passes through to you as an individual (even if your LLC is in NV, where there is no personal income tax), and you still have to pay taxes to your state of residence. For most simple LLCs I just don't see the tax advantages of using another state, in fact it might be more expensive since initial filing fees / franchise taxes might be higher than in your home state.

The other thing to consider is that states like NV don't have an information sharing agreement with the IRS, which allows LLC owners to remain anonymous in public filings. So if maintaining a high degree of privacy is important than you can take that into consideration. Also, certain states might offer marginally more protection for LLCs than other states, but my main takeaway from all of this is that you probably don't need to overthink this too much. Forming an LLC in your home state will be the simplest and should work just fine. There may be reasons to incorporate in other states depending on how you want to structure your entity, but if you are just starting out you are probably not thinking about doing anything super complicated anyway.

Hopefully somebody gets something out of my research. Cheers!

Rather than ask which state, my main questions is do you need an LLC at all?

I would think that being a note buyer has very little risk exposure. If that is the case, and you still want an LLC, I would think paperwork headaches and filing costs would vastly outweigh any subtle advantage of one state over another.

Colorado is probably a fine place to have an LLC.

Yeah, well it's basically LLC vs Sole Proprietorship. The costs of an LLC in CO are pretty cheap ($50 initial filing; $10 annual costs). That's pretty reasonable in order to gain the personal asset protection that comes with doing business under an LLC.

It's not that much hassle to set up initially. The only thing that could be a pain in the future is needing to register as a foreign entity, depending on where I decide to purchase notes. I plan on picking 4-5 markets and I'll check their LLC laws to make sure I'm in the clear.

As far as risk exposure, I am still definitely a newbie, but I have heard that lawsuits are just part of this business. I doubt that the suits would be for any more than my business is worth, but it makes me feel more comfortable having that liability separation between personal assets and business assets.

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