Today I received a question from a reader: “Delaware is home to some of the biggest incorporated businesses in the US, but the TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation ranks the state 50th (worst) in the corporate tax component of your State Business Tax Climate Index. How can that be?”
This is a great question. My answer:
Delaware’s attractiveness for incorporation is driven by many things: favorable incorporation regulations, rules limiting corporate liability, and a second-to-none corporate court system (the Court of Chancery) with judges that are corporate law experts.
The state’s general corporate tax code, however, leaves a lot to be desired. The state levies a top corporate rate of 8.7 percent, and there is additionally a gross receipts taxA gross receipts tax is a tax applied to a company’s gross sales, without deductions for a firm’s business expenses, like costs of goods sold and compensation. Unlike a sales tax, a gross receipts tax is assessed on businesses and apply to business-to-business transactions in addition to final consumer purchases, leading to tax pyramiding. (only five states have these) that businesses pay regardless of profitability. For many businesses though, the pros of the legal and regulatory system in Delaware outweigh the cons of the tax system. This is how Delaware has chosen to compete.
So taxes don’t matter? Not quite. If we look just a little bit further to the other two popular states for incorporation, Nevada and Wyoming, we see that they have chosen to compete on tax policy instead. Those states have no individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , no corporate tax (though that is changing in Nevada this year), and low corporate filing fees. For many businesses, these tax considerations are more important.