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Best State & Tax Entities for Startups

February 17 2021

For startups, your for-profit, state-law entity choices are (1) LLC or (2) corporation. If you’re a Startup, we’re assuming you have plans to (either now or in future) issue equity compensation and/or seek investors. If this is the case, almost all Startups in this scenario choose a corporation that is taxed as a C corporation.

Corporation taxed as C Corp

Why is that? Doesn't C corporations have the dreaded “double tax?”

They do, but the only way you get double-taxed is if you have profits. And if you’re a startup, in virtually every case, you won’t start off profitable. So then that issue is not a problem for you until you’re profitable (which often takes years for startups).

The biggest exception is if you’re going to invest a lot of your money in the first few years of the business but have someone else (you if you have another source of income, your spouse, etc.) that you can use the losses for. In that case, it can be smarter to start off as an LLC or S corp. If it’s your own investment, you can probably take it as a loss with the S corp with some exceptions. And can definitely take it as a loss with an LLC.

But if you’re in that scenario, talk to an attorney -- if you have a ton of money to invest in the company, it’s worth talking to an attorney to find out how to minimize the taxes you pay.

Exceptions aside, C corporations are best for startups particularly for three reasons:

  1. They’re simplest when it comes to equity compensation (which a lot of startups provide);
  2. Venture Capitalists can't invest in S corporations
  3. Investors don’t like to have to file taxes in multiple states. With an LLC or S Corp, they'll potentially have to file taxes in any state that the business generates income.

Delaware is best

So then the issue is -- where should you form your C Corp? In general, for startups, Delaware is best. There are a lot of reasons for this (many of which are probably overblown and don't apply to most businesses), but it's simply the standard that VCs like to see. 

Chris Daming, J.D., LL.M.

Written by Chris Daming, J.D., LL.M.

Chris is the founder and CEO of LegalGPS. Previously, he served in the Army (82nd Airborne), then went to law school and got his J.D. and LL.M. He practiced law and ran the Startup Legal law firm before founding LegalGPS.

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