Setting Up an LLC in Delaware

Forming an LLC in Delaware: Tax and Legal Obligations for Companies

The State of Delaware is one of the most sought-after jurisdictions in the world for US and international business. Forming an LLC in Delaware gives founders strong legal protection, a stable business framework and fast administration. Among investors, however, there is a widespread myth that any entity registered in Delaware is automatically exempt from all taxes and charges.

Taxation in any given case depends on a combination of factors: the legal structure, the chosen tax classification, where the business is actually carried on, the origin of revenue, the tax residence of the members and any physical or economic nexus in other states.

• Forming a Company in Delaware
• Forming an LLC in Delaware
• Taxes in Delaware
• Sales Tax in Delaware
• Tax Returns in Delaware
• Delaware Apostille
• Apostille for a Delaware Business Register Extract

Is Delaware Considered a Tax Haven?

Although Delaware is often described informally as a tax haven, this is an oversimplification. All Delaware companies are governed by US federal legislation and have fixed annual obligations towards the state itself.

Where a company carries on no direct business in Delaware and earns no taxable income there, it may not have to pay local income tax. That does not automatically mean exemption from annual maintenance fees, federal returns or tax obligations in other countries.

We distinguish between the following main categories of obligation:

• US federal income tax,
• Delaware state income tax,
• the annual flat-rate fee (Franchise Tax),
• the local tax on gross receipts (Gross Receipts Tax),
• tax registrations in other US states,
• the founder’s tax obligations in their country of permanent residence.

How Does Taxation Work Once You Have Formed an LLC in Delaware?

In the USA, an LLC is created at state level, but the way it is taxed can vary. From the perspective of the federal tax authority (IRS), it may be treated as a tax-transparent entity (disregarded entity), a partnership or a Corporation.

Single-Member LLC

Where an LLC has a single member, the IRS treats it by default as a “disregarded entity”. For income tax purposes, such a company is not regarded as a separate accounting entity distinct from its owner.

All income and expenses flow straight into the member’s tax return. For employment taxes and certain excise taxes, however, the entity remains separate. This treatment is also confirmed by the official guidance of the IRS.

Where the member is not resident in the USA, the following factors are particularly relevant:

• physical or economic business activity within the USA,
• income derived from US sources,
• the existence of so-called Effectively Connected Income (ECI),
• the presence of employees or business premises in the USA,
• the application of US withholding tax,
• the obligation to file returns with the IRS.

The owner living outside the USA does not, by itself, guarantee automatic exemption from tax.

Multi-Member LLC

A company with two or more members is taxed by default as a partnership. No federal tax is paid at the level of the company itself; its results pass through to the members, who declare them on their personal returns.

Where the members are non-residents and the company generates US-connected income, rules on withholding and paying tax on behalf of foreign partners apply.

Electing to Be Taxed as a Corporation

An LLC may voluntarily opt to be taxed as a Corporation, in which case it becomes subject to the tax rules that apply to corporations.

This model can be beneficial for particular business structures, but you need to compare the tax at company level, the burden on dividends and the legislation in the owner’s country of residence.

How Is a Delaware C Corporation Taxed?

A C Corporation is a separate legal and taxable entity. Its profits are subject to US federal corporate income tax at a basic rate of 21%.

When the company pays out profits to shareholders as dividends, these are taxed in the hands of the recipient. US withholding tax applies to foreign shareholders, with the final amount depending on the type of payment and any international double taxation treaty.

This mechanism is known as economic double taxation.

Delaware State Corporate Income Tax

A Corporation that physically does business in Delaware is subject to state income tax at 8.7% of its apportioned taxable income. Every domestic and foreign Corporation operating in the state must file a return, even if it makes no profit. Further information is available from the Delaware Division of Revenue.

The mere fact of forming an LLC in Delaware or a Corporation does not mean that all worldwide income is subject to this state tax — what counts is the real share of activity connected with Delaware.

Franchise Tax After Forming an LLC in Delaware

Every registered Delaware LLC must pay a compulsory annual state levy known as the Franchise Tax or Annual Tax.

For LLCs, LPs and GPs, this levy is set at USD 400 a year and is due by 1 June at the latest. These entities do not need to submit an annual report with the payment. Full details are summarised in the official instructions for LLCs.

Payment is required even where:

• the company carried out no transactions,
• it made no profit,
• it had no clients,
• the owner lives outside the USA,
• the company has no revenue from Delaware.

The levy remains payable until the company is formally dissolved. A dormant bank account does not mean the company has ceased to exist.

Franchise Tax for a Delaware Corporation

A Delaware Corporation must file an Annual Report and pay franchise tax by 1 March.

The calculation is based on the number of shares, their par value and the company’s assets. Two methods are used:

• Authorized Shares Method,
• Assumed Par Value Capital Method.

The minimum tax is USD 175 under the authorised shares method and USD 400 under the assumed par value method. Choosing the right method can cut annual costs considerably. A calculator is provided by the Delaware Division of Corporations.

What Are the Sales Tax Rules in Delaware?

Delaware has no general state or local sales tax (Sales Tax).

The state does, however, apply a Gross Receipts Tax to sellers and service providers in Delaware. It is charged on gross turnover, and the rate varies by industry. Details are explained by the Delaware Division of Revenue.

If a Delaware LLC sells goods to customers in other US states, it must keep track of whether it creates an economic nexus for Sales Tax in those states.

Reporting Obligation: Form 5472 for Foreign Members

A single-member Delaware LLC owned by a foreign person has strict reporting obligations towards the IRS. Even if it reports no US income tax, it must hold an EIN and file Form 5472 and a pro forma Form 1120 for reportable transactions.

Reportable transactions include:

• capital contributions by the owner,
• payments of funds to the member,
• loans between the owners and the LLC,
• payment of operating expenses by the member.

The filing obligation also applies to dormant companies. The official requirements are set out in the IRS instructions for Form 5472. Non-compliance triggers an initial penalty of USD 25,000.

Taxation in the Founder’s Country of Tax Residence

Forming an LLC in Delaware does not, in itself, automatically shift the owner’s tax position to the USA. If the owner manages the company from the UK, the UK rules on tax residence, the place of effective management and the existence of a permanent establishment need to be assessed.

A foreign founder should analyse:

• where they are tax resident,
• where the business is actually managed,
• where services are performed and where employees are based,
• how payments between the LLC and the member are classified,
• the application of double taxation treaties.

The Most Common Myths About Delaware Taxes

“A Delaware LLC is completely tax-free”

Incorrect. The final burden depends on the revenue structure, the activities and the tax residence of the founders. Every active company pays an annual state levy.

“Zero revenue means zero reporting”

Incorrect. A foreign-owned single-member LLC must file Form 5472 even for internal capital movements with no trading revenue.

“Paying the Delaware fee is enough”

It is not enough. The company must meet its federal obligations towards the IRS as well as the tax rules of the state in which its owner is resident.

“Delaware has no sales tax, so I can sell without registering in the USA”

The lack of Sales Tax in Delaware does not release the company from its obligations in other US states where it creates an economic nexus.

Services and Support With Running a Delaware LLC

Setting up your processes correctly from the outset saves needless spending on penalties and corrective filings.

As part of our administration service, we take care of:

• forming a Delaware LLC or Corporation,
• obtaining an EIN from the IRS,
• providing a Registered Agent service,
• monitoring Franchise Tax deadlines,
• keeping the company in Good Standing,
• obtaining apostilled documents.