How to Make Your Delaware Company Tax Free – Full Guide, Tips & Tricks

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How to Make Your Delaware Company Tax Free
Incorporating in the USA seems like a bad idea at a first glance. Most entrepreneurs would rather focus on low tax jurisdictions – in fact, if you play your cards right, you might be able to avoid tax at all, without even breaking the law.

However, the USA does have some advantages and some states in particular stand out. This is because while the whole country falls under some general laws, each state has the right to come up with its own regulations.

Delaware is one of these states. More and more corporations choose Delaware and for some good reason. But then, just like any other state, it has both advantages and disadvantages. Here is everything you need to know about incorporating a Delaware company.

Benefits of incorporating a Delaware company​

Believe it or not, your Delaware company could be one of the over 1.5 million businesses registered in this state. Another interesting fact is that almost two out of three Fortune 500 companies are actually registered in Delaware. Where is the catch then?

Interview with Laurent Freixe, Executive Vice President/Zone Director, Nestle, Europe
Nestl Holdings, Inc., together with its subsidiaries, manufactures and sells food and beverages; and products related to nutrition. The company is registered in Delaware​

The truth is this state has worked hard to become a top priority for investors. It has changed some of its laws and regulations in order to draw more and more money into the state. Here are some of the main advantages you could have.

Various tax benefits
Delaware offers a bunch of tax benefits – basically, the opportunity to keep more of your profits. At this point, it depends on where you do business. Take an online business – if you do business out of the state, you will not have to pay income tax at all.

Shareholders will also benefit from this state. If you are a shareholder, but you reside in a different state or even country, you will not have to pay tax on your shares in Delaware. Simply put, play your cards right and Delaware could become an interesting tax haven.

Access to a corporation court
If you have ever been in court or have followed a court case, you probably know already how it goes. Judges are trained on more things, but corporations are the last things to consider. Therefore, their decisions are often incorrect – simply because of the lack of experience.

Now, Delaware has a unique Court of Chancery, which is specialized in nothing but corporation cases. Judges are specifically trained on corporate law, so their decisions are accurate and more precise – no room for misunderstandings there.

Quick processing times
Since Delaware is now focused on taking more corporations and bringing money into the state, officials obviously have the interest to make things smooth and easy for those interested in investing or starting a company.

Delaware is committed to being a corporation friendly state. Filings are processed in no time. Believe it or not, if you start the procedure in the morning, chances are it will be processed by the end of the day – forget about waiting for weeks or even months.

Extra anonymity
While being 100% anonymous is nearly impossible these days, the truth is you can always benefit from a bit of extra privacy. Delaware officials know that many directors and wealthy individuals could do with some privacy and local laws help.

When you file in this state, you will no longer have to mention the directors and officers. Their names no longer need to be disclosed to the state of Delaware, so privacy is part of the game – excellent against unscrupulous individuals.

No need for residency
If you think you need to move to Delaware or at least reside there until your company is incorporated, you are wrong. Residency is not required, whether it comes to the directors, shareholders or officers. They can reside anywhere – even in a different country.

Basic corporate structure
Unless you plan to invest hundreds of thousands or even millions in a corporation, you could always do it with a simplified corporate structure that does not involve too much bureaucracy. The size of your company is what makes the difference.

Fortunately, the local law allows you to provide one person to be a director, shareholder and officer. While this is not a great idea for large corporations, it will definitely benefit small businesses that no longer need to find friends or family members for different roles.

Access to wealth
Indeed, a Delaware company implies access to wealth. With so many high net worth individuals and large corporations choosing Delaware, this state is a great opportunity if you are after investors or some venture capital.

Drawbacks of incorporating a Delaware company​

In theory, a Delaware company looks great. There are numerous benefits to take advantage of. It makes no difference what industry you activate in. But then, Delaware is not perfect and there are obviously a few drawbacks too. So, what should you be aware of?

Not too many tax benefits for small companies

Again, Delaware does not tax companies registered in the state that do business out of it. Your home state will, however, tax the company. While you save some money in Delaware, you cannot avoid taxation at all.

If you have a large corporation and you make millions, it is worth it. But if you have a small business and you barely make enough money for small upgrades every year, it is not really worth the hassle, as you will not save too much.

Expensive filing procedures
Filing in Delaware is quick and straightforward – no experience required at all. However, all these benefits come with a cost. Filing in Delaware is more expensive than filing in other states, as fees are high and add up, so you need a considerable budget upfront.

Franchise tax costs
You may not get taxed if you source your income from a different place, but you will still have to pay something – the so called franchise tax. This tax is not the same for everyone, as it depends on the value of your shares.

The franchise tax is not too expensive for small businesses – insignificant. However, as the amount of shares goes up, the tax will grow up proportionally. The same rule applies if the value of your shares goes up.

Furthermore, it depends on where you live – other tastes may double tax you with this franchise tax.

Requirements in other states​

Incorporating in Delaware means you need to follow all the local laws and regulations. On the same note, you also have to meet your own state’s laws and requirements. For example, you have to deal with all the local aspects too.

You may need to look after filing requirements, not to mention licensing laws for your business. Plus, you must file reports on a yearly basis in both states. You will need to work twice as much – or pay twice as much if you choose to hire an expert for this job.

Extra expenses for registered agents
Authorities do not always want to deal with you in person – you have no clue what to do and you can only delay things. When you file, authorities require a registered agent’s name. It could be a self employed professional or perhaps a company.

This entity will be able to accept legal filings in the name of your company. There is one rule – the person or company you choose must be registered in Delaware. Now, this requirement is seen as an additional expense.

Travel requirements for legal disputes
Legal disputes can arise out of nowhere – with or without a reason. There is a problem regarding these disputes. No matter what the case is about, the case must be heard in the local court. Handling legal disputes cannot be done remotely – instead, you must travel to Delaware.

You will also need a local attorney to handle the case, rather than the attorney you might have in your home state. The discomfort is not to be overlooked either, not to mention the hassle of moving to another state – even if you choose to live in a hotel, it will still be an unnecessary expense.

Now that you understand what it takes to run a Delaware company, what else should you know about it?

Delaware company established by a nonresident – A winning concept?​

While anyone can incorporate in Delaware, the truth is nonresidents will have some extra benefits. In fact, this is probably your best option – even better than countries like Estonia, Singapore or Hong Kong, despite the taxation system in the USA.

This scenario is optimal because the USA LLC gives you the opportunity to come up with a low maintenance entity with little to no taxes. More importantly, you get to do all these in a first world country, rather than struggling to find random jurisdictions in the middle of nowhere.

At the same time, this concept brings in benefits in terms of banking. The payment processing selection is also extremely diversified in the USA, not to mention the solid legal system and the access to the American market.

As if all these were not enough, it is one thing to have a company in the USA and a different thing to have a company in Armenia or Estonia. The reputation is definitely higher and will bring in much more credibility.

Now, before moving on with your Delaware company, you need to be aware of the main structures. Each form comes with its own benefits, as well as a few drawbacks. Obviously, these aspects must match your needs. So, what options do you have?

To be a nonresident, you should have no citizenship and no green card. At the same time, you should not meet the substantial presence test in the USA. These are the main requirements defining residency from the IRS.

Understanding the classic corporation​

The classic corporation in the USA is a legal entity. It has nothing to do with the people who own it or manage it. Sure, they are connected, but the truth is they are not really responsible for anything from a legal point of view.

The corporation is registered when Delaware releases the certificate of incorporation. This certificate has more meanings, but from a legal point of view, it means the entity can sue or be sued, sign agreements, deal with contracts and so on.

Here comes the good news – shareholders are exempt from liability. It makes no difference how much debt the corporation has. As long as the shareholders perform their duties by the law – whether they are officers or directors, there is nothing one can do against them.

This type of protection is referred to as the limited liability.

If you are familiar with company structures in other first world countries, there are not too many differences. This corporation is similar to the limited company in the UK or perhaps the SARL in France – same type of protection.

There is a federal corporate tax around the USA, which is 21%. On the other hand, income tax at a state level varies from one place to another. You will have to pay it in the state where the company is incorporated – Delaware does not have such a tax.

Once the corporate income tax is paid, you can then share profits accordingly. You can pay yourself as a shareholder, for example. You can also declare dividends – they could be taxable, but then again, it depends on where you live.

Becoming familiar with the partnership​

The partnership structure is not to be overlooked either. In fact, becoming familiar with it will help you understand the LLC structure. Just like the corporation, the partnership is a structure – you will need at least one partner.

You come up with an agreement that involves a particular sharing system based on profits, losses and management. The partnership is declared as a legal entity, but it does not pay tax separately. Instead, profits and losses are passed to each partner.

To keep it simple, the partnership does not pay tax as a business, but owners are taxed on the income.

Defining the LLC structure​

Pretty much every country out there has similar structures, but you are less likely to find the LLC – Limited Liability Company. It is similar to limited companies in other countries, but it does have a bunch of particularities.

In the USA, the LLC is a legal entity – from many points of view, similar to the partnership or corporation. However, some would describe it as a hybrid option between these two structures. It has the limited liability protection from corporations and the tax efficiency and flexibility from partnerships.

LLC owners are referred to as members. They can be people or other entities – businesses.

When it comes to taxation, the LLC is not taxed like a corporation. Instead, most members are taxed one at a time, like in a partnership. However, unlike partnerships, LLCs can be established by one person only.

Defining foreign income and local income
The source of income makes the difference when about to establish a Delaware company. It might be relevant for your business, but it helps when you optimize tax. The source of income is the place where income originates from or is generated in.

In other words, establish a company in Delaware and you will not be taxed for foreign sourced income. Take interest income, for example. It is foreign sourced if the debtor is a foreign resident or even a foreign company.

How about the gain on the sale of properties? If these properties are located in the USA, it is no longer considered foreign source income. If it is abroad, you will not be taxed for it. Personal service income is in the same category – offer a local service and you will be taxed.

Now, there is also a middle option out there. For example, imagine having a marketing company established in Delaware. You sell online marketing services to a company in the USA, but you do not have any employees in the USA – the income is considered foreign sourced.

Any sale through a local office is considered local.

There is another concept that could make the difference here. The so called ETBUS – Engaging in Trade or Business in the USA – is not to be overlooked either. However, it is a bit sketchy and can confuse anyone, including accountants.

The idea is simple – this concept comes first and income from local sources comes second.

Basically, you need to check if you engage in trade or business in the USA before anything else. Then, you must check if you have any income sources in the USA. If the answer is positive to both aspects, you must pay federal tax in the USA.

On the other hand, local income is not taxed if you are not engaging in trade or business in the USA. To keep it simple, even if your income is sourced locally, you will not have to pay income tax if you do not engage in trade or business in the USA.

Once you join the ETBUS category, you need to determine the source of your income and figure out if it is sourced locally. Only then you will be able to tell whether or not you will have to pay income tax in the USA.

Another option implies considering tax treaties.
First, you need to check your country of residence. Does it have a tax treaty with the USA? USA is one of the few countries out there that could double tax you. Double taxation avoidance agreements can save you in this case.

If you count yourself in such a category, you can overcome tax. Permanent establishment relates to a company with a fixed location for business. If this location is in another country and you pay tax here, the American location becomes irrelevant.

Such a tax treaty list is maintained by the IRS, so you will have to check the official website regularly.

How to make your Delaware company tax free​

All these concepts can be confusing, so hiring an accountant might help – you need someone with experience in such things. After all, some of these aspects can be confusing for accountants as well – the last thing you want is to pay tax when you should not.

Now, to keep things simple, here is a checklist to keep your Delaware company tax free.
  • Make sure you do not employ any people in the USA.
  • You should not have any exclusive contractors in the USA.
  • Do not include Americans among your LLC members.
  • Do not reside in the USA for 120 days a year or more.
Such rules could change anytime, so make sure you keep an eye on them.

When the LLC becomes a bad idea​

The LLC Delaware company sounds like a perfect option, but you should not use it for all of your needs. There are situations when the classic LLC is not suitable at all because it can actually add to your burden in the long run.

If you are after investments in the USA, the LLC is not a good idea. It makes no difference if you are after VC or angel investments – when they come from a local source, the LLC will lose some of its benefits.

Then, having an American among the members of the LLC is also a bad idea. To keep it tax free, you need the LLC to have foreign members only. If not possible, opt for a different structure.

Interested in issuing stock options to employees? A corporation could be a better idea then. Otherwise, you will end up taxed.

Conclusion​

Bottom line, a Delaware company is an excellent opportunity for certain categories of people. It is no surprise why so many companies are incorporated in this state. With friendly laws and a good organization to draw investment, Delaware is probably the hottest tax haven in a first world country.

At the end of the day, it clearly depends on your business goals and structure. Small details can make the difference between getting heavily taxed and avoiding taxes. Sure, there are some extra expenses involved, but they are worth the money you can save for not paying tax.
 
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Great Article on Delaware Corporation

For billing my clients in UK (I am non-UK / Non-USA resident) using Delaware Corp

I plan to accumulate the money (USD 50,000 per year) in Corp. for some years.

For a Delaware company, what happen for following :-

1) there is no State or Federal Tax Payable - is this correct?

2) If I invest the money held in the company in the Stock, Shares, bonds, options etc in the USA - is there income tax or Capital gains tax for any growth ? does this fall under "local" income ?

3) if the money is eventually paid out as a dividend to the foreign shareholder - what is the tax payable in the USA?
 
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