Duh, Inc.

February 5, 2007 2:14 PM

Why do companies incorporate in DE, and have we done something incorrect by doing so when our primary place of business is NY?

A friend and I recently came upon an opportunity to potentially sell some software we wrote in our spare time. In order to deal with us, the company we were talking to needed us to be properly incorporated. (Which we knew we needed to do anyway)

So we talked to a few friends, and one of them was gracious enough to help us out in choosing the correct structure (s-corp), and file most of the appropriate information. They advised us to incorporate in Delaware and so we also got set up with a holding company.

I recently met with an accountant (CPA) because we are at the stage where we want to make sure we have all our ducks in a row, as well as do tax planning for 2007.

Here are some facts. I live in Manhattan, NYC. My partner lives in California. Our primary place of business will probably be New York, but we will almost definitely have another client in NJ. When I told the CPA about this, he seemed a little shocked that we were advised to incorporate in DE. His advice was to dissolve the DE company before any business takes place with it, and reincorporate in NY.

He said if we really wanted to, we could stay incorporated in DE, but it seemed like the main reason he didn't want that was because we would have to apply to NY state as a foreign company to get the authority to do business in NY, and file a DE tax return. We would rather not dissolve the DE company, since we already paid for the holding company and the DE incorporation costs, roughly $300.00. We would end up spending about $700.00 to dissolve and reincorporate in NY.

Here are my questions.

1)Why do people incorporate in DE?
2)Can anyone recommend to us what to do (stay incorporated in DE or dissolve and incorporate in NY?)
3)Isn't it fairly common practice to incorporate in DE? My full time employer is incorporated in DE, but has offices all over the world, as do tons of companies listed on the NYSE, etc.

Thanks. We should have talked to a CPA before getting this far into it and potentially wasting some money, but oh Internet! Help us figure out what to do! (Get a second opinion is a valid response)

posted by zackola to work & money (17 comments total)

Wikipedia on Delaware corporations.
posted by grouse at 2:27 PM on February 5, 2007

There is no corporate income tax in Delaware, hence why a lot of companies incorporate there. Including, for example, Disney and a host of credit card companies.

Whether you should dissolve your DE corporation and reincorporate in NY, I don't know, but you should probably listen to your accountant.
posted by chimaera at 2:28 PM on February 5, 2007

chimaera: Delaware does have corporate income tax, but only on income apportioned to Delaware. They don't charge tax on income elsewhere, but neither does any other state.
posted by grouse at 2:36 PM on February 5, 2007

Talk to another CPA. Your CPA might just not be prepared to deal with the perceived hassle.

I do have some qualms with incorporating in Delaware, but I guess if you can't beat em ...
posted by o0o0o at 2:44 PM on February 5, 2007

Much of the reason many companies incorporate in DE is described in the "Legal Benefits" section described in the Wikipedia entry linked by grouse. The key part is that because so many companies already have been incorporated there over the years, the DE court system is extremely well-versed in corporate law. This makes it easier to predict the results of cases which, among other things, reduces overall litigation costs by encouraging settlement. As a result, the more companies that incorporate in Delaware, the more valuable it becomes for other companies to incorporate in Delaware (an example of a network externality).

That's about the extent of my knowledge, so I can't really give you any advice on your particular situation.
posted by Partial Law at 3:08 PM on February 5, 2007

You could leave things as is without any problem. If you take a look at large corporations in New York, you will see that a large number of them are incorporated in Delaware.

Tax reasons are likely a non-issue. Most if not all states tax economic activity taking place within their borders, regardless of where the company is incorporated.
posted by yclipse at 3:21 PM on February 5, 2007

Delaware (like many other states) also charges a yearly franchise tax to all corporations incorporated in the state (irrespective of where they do business). Anecdotally, I've been told that DE's is on the high side, but I'm not in a position to evaluate it with respect to NY's.

Law professors have spilled oceans of ink discussing the drive to incorporate in DE, and the consensus seems to be that the state's primary advantages are a predictable corporate legal regime and a highly-trained, competent corporate judiciary. DE has special corporate courts, and this is believed to lead to better decisions.

Basically, if your CPA says there are compelling reasons to use a NY corporation, the advantages of a DE probably aren't worth it--unless you're planning on massive shareholder derivative suits, playing with novel merger provisions, or so on.
posted by Mr. President Dr. Steve Elvis America at 3:55 PM on February 5, 2007 [1 favorite]

First of all, why are you listening to your accountant about where and how to incorporate? Talk to a lawyer.

The key part is that because so many companies already have been incorporated there over the years, the DE court system is extremely well-versed in corporate law.

Sort of. This is a benefit, but I wouldn't call it the "key part." Unless you take the cynical (but not entirely inaccurate) point of view that "experienced court" is a synonym for "captured court." More to the point is that Delaware tends to have relatively management-and-board friendly doctrines on issues like "business judgments" (that may not be clearly in shareholders' best interests) and managerial attempts to rebuff takeovers. Mostly these are issues in public companies, and so it probably doesn't matter where the poster's (closely held, right?) S-Corp is formed. Furthermore, Delaware has been the standard bearer on corporate law issues for so long now that it's not always clear that other states are in fact significantly different; they tend to look to DE Chancery opinions for guidance when new issues arise.
posted by rkent at 3:58 PM on February 5, 2007

Whoa, just noticed that wikipedia page on regulatory capture is total crap; this pdf (linked at the bottom of the article) is quite a bit more thorough, if hella-long.
posted by rkent at 4:00 PM on February 5, 2007

Aaaand, this blog post is a much shorter and more concise description of the phenomenon, to which I should've linked originally. OK, I'm done now.
posted by rkent at 4:02 PM on February 5, 2007

If you have an office in New York, you may be required to qualify as a foreign (that is, non-Delaware) corporation in New York -- with the NYS Department of State, specifically. Please don't overlook this possible requirement!
posted by Lockjaw at 4:12 PM on February 5, 2007

I read the wikipedia article, and on the tax issue, I stand corrected.

But my other advice still stands: your accountant will be able to help you with the cost/benefit analysis of dissolving/reincorporating.
posted by chimaera at 4:28 PM on February 5, 2007

That's fair, rkent. I should have said "a key part."
posted by Partial Law at 4:36 PM on February 5, 2007

My instinct is that your CPA is making sense. For a small corporation (closely held, I'm assuming) it's not common to incorporate in DE if the primary place of business is elsewhere. I think convenience also weighs in favor of keeping it in NY.

Application For Authority - that will be $225, and note the requirements about doing business prior to filing.

I think a visit with a lawyer, one with some significant corporate experience, is a good idea. You may be fine, you may not be - but you probably want to know for sure either way so that you don't end up with problems that you or your CPA wouldn't have foreseen. It's a good idea to run the whole situation by that lawyer - he might pick up on issues that we don't even know are issues. If you want to save money, a lot of community programs have clinics that can give you some advice, but I can't vouch for the quality of any in NY.
posted by KAS at 5:04 PM on February 5, 2007

I was an admin for a CA/NY based start up from the beginning of the company, and we incorporated in DE. Of course, this is a company that is doing the whole VC investor thing, and is trying to take their product to market, so this may not apply to you. However, 2 things were pretty invaluable in my time there: the lawyer and the accountant. Both were specialists in start-up companies. The lawyer is the one who recommended incorporating in DE, and the accountant didn't blink an eye when we gave her copies of the articles. If you can find a CPA who is experienced in working with start-ups, it wouldn't hurt to get a second opinion.
posted by deedeep at 7:34 PM on February 5, 2007

as a small company you will not derive any significant benefit from delaware incorporation. However if you grow significantly you should consider re-incorporating in delaware. The discussion is rather complex (I am finishing a thesis on a related side topic to this) and a lawyer should advise you when this becomes a consideration ... hovever if there are only a few owners of your company and you are not making much money don't bother with delaware.
posted by jannw at 4:36 AM on February 6, 2007

I can provide two data points:

I'm a partner in a small NYC company that incorporated 13 years ago in DE, and none of our lawyers or accountants have ever suggested that we should not have.

I'm also a partner in a startup that has one partner in NYC and one in Maine, and we incorporated in DE, and haven't heard from any of the very aggressive lawyers and VCs we're dealing with that we should not have.
posted by nicwolff at 12:05 PM on February 6, 2007