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The choice of state and legal form for incorporating your U.S. entity is important from a tax, legal and financial point of view.
Incorporating an entity in the United States is relatively simple and inexpensive and several forms are possible:
C Corporation (C Corp)
Its characteristics are similar to those of a corporation in Canada. The shareholders’ liability is limited.
S Corporation (S Corp)
Only individuals who are U.S. tax residents can be shareholders of this type of entity. As a result, this type of entity is generally not accessible to Canadians. From a legal perspective, it is a C Corp, however, it is a transparent entity from a tax perspective: it is not the corporation that is taxed on the income, but rather the shareholders.
Partnerships
In these transparent entities, it is the shareholders who are directly taxed on the entity’s profits. Partnerships can be:
- General partnerships, or GP;
- Limited partnerships, or LP;
- Limited liability partnership, or LLP or Limited liability limited partnership or LLLP.
LLC (Limited Liability Company)
This legal form provides legal protection similar to the C Corp and is widely used by Americans. In general, however, Canadians should avoid direct investments in this form of entity, as it can result in double taxation.
This problem arises because tax authorities in the two countries do not view an LLC in the same way. The Canadian tax authorities treat it as a corporation, while the U.S. tax authorities treat it as a transparent entity, meaning that it is the shareholders who are directly taxed on the entity’s income.
In which state should you incorporate?
No, Delaware is not a tax haven. If more than one million companies have chosen to incorporate there, it is simply because Delaware offers a very favourable environment because of the following:
- quick and easy incorporation process;
- low incorporation cost and lower annual fees;
- business-friendly legislation that is regularly updated;
- presence of courts dedicated to commercial matters;
- confidentiality regarding the identity and contact information of shareholders and directors;
- no income tax returns to be filed for the state unless there is activity;
- no obligation to maintain a head office in the state;
- no minimum investment required.
That said, the choice of state to incorporate your entity depends on whether you do business in a single state or multiple states.
In a single state
It is preferable to choose the state where you do business, because it is simpler to manage and easier to settle possible disputes with your business partners.
In several states
It is preferable to consider a state where you carry out your main activities or Delaware.
Remember that each state has its own tax system with its own rules, obligations and tax credits. In fact, many states have different types of taxation: income tax, minimum tax based on sales, etc.
Note that you must file a tax return in each state where you have a sufficient physical or economic connection, which is called nexus.
According to the Tax Foundation’s 2020 State Corporate Income Tax Rates and Brackets, 44 states have corporate income taxes and the rates range from 2.5% to 12%. What about Delaware? Its rate is above the average, at 8.7%.
If you are considering incorporating an entity in the U.S., it’s best to consult with lawyers and tax professionals who specialize in cross-border matters.