Where to incorporate software startup?

The scenario: we are a startup software company that will be selling our applications through Apple's network (iTunes and Mac App Store).

One co-founder is located in Toronto, Ontario. The other in San Francisco, California.

We are planning on forming an LLC and have the following goals:

-minimize tax
-stay out of jail

It seems like Delaware is a favorable location to form an LLC ($200 annual fee for an LLC vs. California's $800).

I know that if we are considered as an entity 'conducting business' in California we would have to register as a foreign entity in that state and pay the applicable fees, but I am struggling with what constitutes conducting business.

We would open up a bank account in Delaware, so all financial transactions would occur there. We have no employees, and no business partnerships would be formed in California.

Any advice on where / how to form an LLC would be greatly appreciated. Thanks in advance!

There is quite a bit of case law behind the entire issue of internet taxation. Generally, in order to be taxed in a particular state, a business must have a “substantial nexus” to the state. This depends on the existence of 1) Headquarters, 2) Employees, 3) Bank Accounts, 4) Servers, and/or 5) Return stores (Non-employee founders are not on this list...). If the company has one or any factor of these things, it is likely to have some “nexus” to the state. No single factor is determinative, and each case must be determined on a case-by-case basis.

Think about whether California would go after you and on what basis. Also think about what assets they would be able to access/not access even if it did go after you (and by "you" that actually means the LLC - so think about whether jail is even applicable). Also look at California's enforcement budget for these matters (lol).

The minimum annual franchise tax in California for simply having an LLC REGARDLESS of whether it is profitable or not is a whopping $800. Corporations are exempt from this tax for one year. So also think about the business entity you want to go with should you decide to go with California.

Disclaimer: This post does not constitute legal advice and does not establish an attorney-client relationship.

I'm no lawyer as well but when I was looking at incorporating my business my lawyers at the time were really pushing for delaware for the following reasons:

• They take care of all the hassle (which has a cost)
• VC prefer Delaware for legal purposes (the state has a long history of legal stuff in delaware)
• You will do a C-Corp (VC prefer it) instead of an LLC (it has Shares!!)
• For acquisitions, litigations, IPO, etc.. Delaware is better.
• You still need to declare your business in california (a bit of overhead) and pay taxes in california.

Now if you don't plan to involve VC rapidly. LImit overheads and file your business in California and do an LLC. My Advice = Focus on your business not tax optimization, it will bring overhead, and consume your time and take away your focus. How much taxes are you really going to save when you are at a stage where you make very little money? It is not worth it, if your business is successful, you can have the right lawyers and overhead then.

Cheers

I am not a lawyer but this is what I did for my company. I considered both Delaware and Nevada. After discussing my options with my CPA/Attorney he recommended California since I was living and doing business there. From what I understand is if you setup a corporation in a different state than where you live, you need to have someone in that state represent you. If costs are a concern, you might want to take that into consideration.

For me coming up with $800 a year is a pain, but I have less tax issues to worry about. My company is a S-Corp which helps with my personal taxes as well.