A tax shelter is any method of reducing taxable income that results in a reduction of tax payments. In the United States, a tax shelter is loosely defined as any method that recovers more than $1 in tax for every $1 spent within a four-year period. The specific methodology varies depending on local and international laws, but a tax shelter can be created by either an individual or a corporation.
For U.S. corporations, states such as Nevada and Delaware provide favorable tax shelters, which has led increasingly high numbers of companies to incorporate in these states. However, by offering slightly more tax benefits to its corporations, Delaware has skewed the number of corporate filings in its direction.
Before deciding to incorporate in Delaware, however, company owners should know what makes it a good tax shelter.
- Delaware is particularly attractive financial companies, due to its business-friendly usury laws and light taxation.
- A Delaware corporation can base their headquarters in any U.S. state, where they are then exempt from state corporate income tax in many cases.
- Delaware corporations are also subject to a more favorable legal process the state's Court of Chancery.
Incorporation in Delaware affords companies numerous benefits. Businesses might not have to disclose who their officers and directors when they file documents in the state at the time of a company’s formation.
Furthermore, if the business does not conduct its operations in Delaware, the state’s corporate income tax may not apply. Instead of paying that income tax, those Delaware corporations instead pay a much lower franchise tax. Delaware also has business-friendly usury laws, which allow banks and credit card companies to have much more freedom to charge higher interest rates on loans.
Delaware's Court of Chancery is a well-respected court of equity that resolves disputes between Delaware corporations and has an extensive set of precedents, statutes and case studies from their 200-plus years of operation. Decisions from the Court of Chancery have routinely set the benchmark for U.S. corporate law; the court's experience can be very beneficial to Delaware-incorporated companies that seek guidance on particular issues. We will look at these factors in a little more detail below.
No State Taxes
There is no sales tax in Delaware. It doesn't matter if a company's physical location is in the state or not; as a Delaware corporation, no in-state purchases are subject to tax. Additionally, there is no state corporate income tax on goods and services provided by Delaware corporations operating outside of Delaware.
The state does not have a corporate tax on interest or other investment income that a Delaware holding company earns. If a holding corporation owns fixed-income investments or equity investments, it isn't taxed on its gains on the state level.
Delaware also does not have any personal property tax. There is sometimes a county-level real estate property tax, but that tax is very low compared to other states. Corporations can own their own office spaces and reduce the amount of property tax compared to other states.
The state has no value-added taxes (VATs), it does not tax business transactions, and it does not have use, inventory or unitary tax. There is no inheritance tax in Delaware, and there are no capital shares or stock transfer taxes.
Small Amount of Franchise and LLC Tax
Most states require annual franchise and LLC taxes based on earned income. Delaware’s franchise tax is an annual flat fee for limited partnerships and limited liability companies.
The franchise tax for corporations is calculated based on the type of corporation, the number of authorized shares, and other factors. Delaware, however, offers a flat-fee franchise tax of $100 and a flat-fee LLC tax of $250. Compared to other states, Delaware offers exponentially lower franchise taxes and LLC taxes.
Local laws offer confidentiality by shielding the identities and personal information of privately held corporate business owners from public record. Even when business owners file incorporation papers, the state only requires filing the name of the entity and the name and address of the registered agent. Additionally, Delaware doesn't require the names and addresses of LLC members and managers to be made public.
S-Corporations and LLCs
The state of Delaware permits S-corporations (S-corps), which can be very advantageous from a tax perspective. S-corps have shareholders, but they are not taxed at the federal level. Instead, these corporations are treated as pass-through entities, similar to LLCs, so all income or losses are passed through to their shareholders.
LLCs are also permitted in the state of Delaware. These types of corporations allow business owners to write off any losses and actualize their gains. Through the use of S-corps and LLCs, it's possible for a business to reduce its quarterly tax payments.
Separate Court System
Delaware has a separate court system called the Court of Chancery. This court allows the state to adjudicate corporate litigation, and its corporate laws regularly influence Supreme Court decisions. The Delaware State Bar Association regularly reviews Delaware's corporate laws. This gives entities incorporated in Delaware a more favorable system of reviewing legal matters if any tax laws need to be reviewed.