If you’re starting a new business in California, one of the first decisions you’ll face is where to form your legal entity. It’s not uncommon for entrepreneurs to hear that states like Delaware, Nevada, or Wyoming offer “better” benefits—lower taxes, more privacy, fewer regulations, and so on. But before you rush off to register your California-based business somewhere else, let’s take a closer look at why incorporating in California is usually the most practical and cost-effective choice for businesses that operate primarily in this state.
Forming Your Business in California: Pros and Cons
Pros/Reasons to Form in California:
- You avoid dual registration and fees. If you form your business in another state but operate primarily in California, you’ll still need to register as a foreign entity here. That means paying two sets of formation fees, annual franchise taxes, and registered agent fees.
- Simplicity and administrative ease. Keeping your filings, compliance, and correspondence within one jurisdiction reduces the risk of missing deadlines or requirements.
- Local legal familiarity. California courts and attorneys are more accustomed to handling disputes involving California entities, meaning your rights and obligations are typically more predictable.
- Tax alignment. Depending on your situation, there may be tax advantages to forming in California, especially if all of your revenue is earned here anyway. But (and here’s your first friendly reminder), consult your tax professional for a real answer.
- Consumer and employee protections. California laws tend to be more protective of consumers and workers. If your operations are here, you’re subject to those laws regardless—so you might as well form here too.
- California judicial system. Generally speaking, businesses that operate and do business in California need to be registered in California in order to maintain or participate in a legal action filed in California state courts.
Cons:
- Higher franchise tax minimums. California’s minimum $800 annual franchise tax is steep compared to some other states.
- Lower privacy protections. Some states (like Wyoming or Delaware) allow for greater anonymity in business filings. California requires more transparency in ownership and management—but that doesn’t mean other states offer true anonymity. In many cases, privacy is only partial and can be pierced by court order or legal process. So, forming out-of-state for privacy reasons may not offer the cloak some entrepreneurs think it does.
What Can Go Wrong When You Incorporate Elsewhere
Let’s walk through a quick hypothetical:
Suppose Jane is launching a small e-commerce company out of her Los Angeles garage. She reads an article online claiming that forming an LLC in Nevada will save her money. She files in Nevada, pays a registered agent to maintain the address there, and gets up and running.
Six months later, business is booming, but Jane didn’t realize she also needed to register her Nevada LLC in California as a foreign entity. She also hasn’t paid California’s franchise tax or filed the necessary statements of information here. When she applies for a small business loan, the lender raises red flags over her non-compliance. She gets hit with back fees, penalties, and potentially a suspension notice from the Secretary of State. The Nevada savings? Long gone.
Admittedly, this example is unlikely to lead to state action against Jane or Jane’s entity. However, it is important to consider the possible harm. For example, Corporation’s Code Sections 2258 and 2259 provides for monetary fines for failure to properly register. Corporations Code Sections 2203(c) (regarding corporations) and 17708.07(a) (regarding LLCs) and Revenue & Taxation Code Section 23301 are also relevant. These three sections basically can bar a suspended or improperly registered entity from participating in a lawsuit or enforcing a contract in California.
Now she’s paying two franchise taxes, two annual report fees, and dealing with administrative cleanup—and possibly IRS scrutiny.
What’s worse: the business formation service Jane used didn’t give ongoing support or tax guidance. Which brings us to friendly reminder number two: your business attorney is not your tax advisor. Retain a qualified tax professional—not just during formation, but year-round.
But What About Delaware? Isn’t That Where All the Big Companies Form?
Yes, Delaware is favored by large corporations with complex capitalization structures and a national (or international) presence. It has a well-developed business court (the Court of Chancery), which is ideal for companies dealing with shareholders, mergers, or IPOs.
But if you’re a local California business—a restaurant, consulting firm, startup, or retail store—you’re probably not going public anytime soon. Forming in Delaware may add complexity and cost without delivering any meaningful benefit.
So When Might Forming Outside California Make Sense?
- You’re raising capital from venture capitalists who require a Delaware C-Corp.
- You’re operating in multiple states and California is not your primary market.
- You have a compelling strategic or legal reason advised by both your attorney and tax professional.
But even then, it’s worth pausing to make sure the cost-benefit math truly pencils out.
Final Thoughts
Forming a legal entity is more than checking boxes and paying a fee—it’s about building a legal and financial foundation that will support your business long-term. If you’re operating primarily in California, incorporating here is almost always the most sensible route. It reduces compliance headaches, keeps your costs aligned with reality, and avoids the pitfalls of multi-state obligations.
So yes, call your business attorney. But also—don’t forget your CPA! They’re the ones who can make sure you don’t lose money in an attempt to save on some expenses.