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February 21, 2023

Cross-Border Update

Q1, 2023—"Forming a Corporation in the United States: Is Delaware Always the Right Choice?"

Barclay Damon’s corporate attorneys regularly receive requests from Canadian attorneys, accountants, and business owners for assistance forming corporations in the United States. These requests usually relate to the expansion of the client’s business into the US market. Many of these requests are based on an assumption that the new US corporation (Newco) should be formed in Delaware. Is Delaware always the right choice?

Unlike Canada, the United States does not allow for the formation of “federal” corporations. Instead, corporations are formed at the state level. Because the United States is comprised of 50 different states, there are 50 different jurisdictions in which Newco can be formed.

Why is Delaware preferred by many practitioners? Delaware’s corporate law is very advanced and sophisticated, and the state has worked hard to create filing processes that are efficient and cost effective. Delaware enables attorneys to form corporations, file amendments, and effect mergers and other reorganizations in an extremely simple and timely manner. Additionally, filing fees in Delaware are reasonable. 

Many of the people we speak with have heard Delaware is “tax free” and believe forming Newco there will enable them to operate in the United States tax free. While it is correct that Delaware does not have a state-level corporate tax, essentially all corporations (including those formed in Delaware) must file a US federal tax return and pay federal taxes on their taxable income. Newco may also be required to file tax returns and pay state-level taxes in those states in which it has substantial sales or other substantial business activities. This is the concept of tax “nexus.” For example, if Newco is a Delaware corporation but derives substantial revenue from Pennsylvania, it will likely have tax nexus in Pennsylvania and will have to pay Pennsylvania corporate taxes on its taxable income derived from Pennsylvania.

Delaware is also an excellent state in which to form Newco if Newco will not have a physical facility in another state (e.g., an internet sales company) or if the client is unsure about Newco’s long-term expansion plans, where Newco will be based on a long-term basis, or both. As Newco’s business develops, a Delaware Newco can be registered to do business in other states where the level of its activities necessitates. For example, if the Delaware Newco decides to build a plant in Florida, or establish an office in Texas, or set up a service team in Ohio, the Delaware Newco can easily be registered to do business in those states.

Are there any disadvantages to forming Newco in Delaware? Not really. Keep in mind that every Delaware corporation must file an annual report and maintain a registered agent in Delaware. These annual costs usually amount to less than $1,000. The issue we sometimes deal with is when the client has decided to open an office in another state (let’s say New York) and knows it will be based in New York on a long-term basis. In those circumstances, we could form Newco in Delaware and then register Newco to do business in New York. However, once registered in New York, Newco will essentially be treated as a New York corporation for most regulatory and tax reporting purposes. So, if Newco is going to be based in New York on a long-term basis, why incur the annual fees in Delaware when Newco could have been formed as a New York corporation instead? There may be other factors that result in forming Newco as a Delaware corporation anyway, but this is the basic scenario that sometimes results in the decision to form Newco in a different state.

If you have an interest in forming a corporation (or any other business entity) in the United States, Barclay Damon’s corporate and Canada-US cross-border attorneys will be pleased to discuss your business goals as well as other topics related to expanding your business to the United States.
 

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