Why you shouldn't form an LLC outside of your home state

When you form a new limited liability company (LLC), you have the option to organize in a state of your choosing. However, your best choice is almost always going to be your home state. Here's why.

LLC formation requirements

Forming an LLC typically involves filing certain formation documents—most notably, the articles of organization or certificate of formation—with the Secretary of State or similar governmental entity that regulates new and existing businesses in whichever state you believe will provide the greatest range of benefits.

Many argue that by filing the LLC formation documents outside your home state—that is, by filing as a non-resident in a "foreign" state—you run the risk that:

• You'll still need to foreign qualify your entity in your home state, and file annual reports and taxes
• The laws and processes for filing the formation documents are unfamiliar to you
• The fees are higher than at home or include annual fees beyond the initial filing fee

Additionally, you may discover only after the LLC formation documents have been filed that the foreign state of formation:

• Requires you to obtain a business license and pay added fees to operate the LLC legally
• Is not as "business-friendly" as you had hoped or envisioned

The foreign qualification process

If you plan on doing business outside of your home state, you need to understand and appreciate that almost every state has separate requirements for LLCs to qualify as a "foreign" LLC.

To strictly adhere to the "foreign qualification process" requirements, you'll need to complete and file separate foreign LLC registration forms and pay the statutory fees in any states in which your LLC will transact business. This may include your home state if the LLC will be doing business there as well.

This additional step can become rather time-consuming and costly, particularly if you anticipate registering in multiple other states, in addition to or aside from your own.

Each state has particular rules around what it means to be "doing business" in the state, so it's best to consult with an attorney to determine if you meet the definition.

The legal shield that normally protects you from incurring personal liability within the LLC structure will be stripped from you, thereby exposing you to personal liability for the company's debts, collection actions, and lawsuits.

These strict registration requirements and possible consequences of defaulting on them can compound the amount of stress you have already placed on yourself—and other LLC members—by forming an LLC outside of your home state.

The registered agent requirement

Forming an LLC outside of your home state has the added disadvantage of requiring you to retain and designate a registered agent for the LLC within the state(s) of formation and pay initial and ongoing registered agent fees. You'll also need to designate a registered agent in each state where your LLC needs to foreign qualify.

The registered agent is obligated to accept service of process and other important legal documents on behalf of the LLC in the event a collection action, lawsuit, or other claim is brought against the LLC.

Those fees can be a drain on the budget, not to mention the attorney's fees that may be required to retain an out-of-state attorney to defend the matters.

Double taxation issue

If you still think that forming an LLC outside of your home state is worthwhile, you'll probably want to consider the potential "double taxation" issue that may surface if you plan to form an LLC out-of-state and conduct business in your own state.

If you were planning on conducting business in a foreign state, you'd be required to strictly comply with the foreign qualification process in that state. And, if you also decide to simultaneously transact business and separately file LLC formation documents in your home state, you might be subject to paying business income tax, and perhaps franchise taxes as well, in the foreign state and in your own state.

Because you may be saddled with paying taxes in both the foreign state and home state, it might make more sense to form your LLC in your home state and therefore only have to pay taxes in one state.

If you have questions about the pros and cons of filing in a foreign state versus your home state, it's best to consult with an attorney, financial advisor, or tax expert in your state.