A tax shelter is any method of reducing taxable income that results in a reduction of tax payments. In the U.S., 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, Delaware is a favorable tax shelter; however, before deciding to incorporate in Delaware, company owners should know what makes it a good tax shelter.
Key Takeaways
- Delaware is particularly attractive to financial companies, due to its business-friendly usury laws and light taxation.
- A Delaware corporation can base its headquarters in any U.S. state, where it is then exempt from state corporate income tax in many cases.
- Delaware corporations are also subject to a more favorable legal process by the state's Court of Chancery.
Delaware Corporations
Incorporation in Delaware affords companies numerous benefits. Businesses might not have to disclose who their officers and directors are 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, Delaware corporations instead pay a much lower franchise tax.Delaware also has business-friendlyusury 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 since its inception in 1792.
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.
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.
Delaware's graduated personal income tax ranges from 2.20% to 6.60% in 2023.
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. According to the state:
- The minimum tax is $175, using the Authorized Shares Method
- The minimum tax is 400 using the Assumed Par Value Capital Method
- A maximum tax of $200,000 for both methods unless;
- It has been identified as aLarge Corporate Filer then its tax will be $250,000.
Corporate Privacy
Local laws offer confidentiality by shielding the identities and personal information of privately held corporate business owners from public records. 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.
What Is the Delaware Tax Loophole?
The Delaware tax loophole allows companies to avoid paying corporate state income tax by setting up a subsidiary in Delaware where a company can transfer intangible assets; Delaware does not tax intangible assets, so a company does not have to pay taxes on the money it transfers to this subsidiary. The company can deduct the money (usually royalties) it sends to the subsidiary in the state in which it is incorporated.
Why Is Delaware Called a Tax Haven?
Delaware is a tax haven for many reasons, including no sales tax, the Delaware tax loophole, a low corporate income tax, business-friendly laws, and a beneficial franchise tax system.
What Is Delaware's Corporate Income Tax?
Delaware's corporate income tax is 8.70% as of 2023.
The Bottom Line
States create their own tax laws and many create ones that are favorable to businesses. Delaware is one of many states that have favorable tax treatments for corporations in order to entice these businesses to set up shop in the state. This is a mutually beneficial relationship as it allows businesses to pay less in taxes while bringing jobs, revenues, and more to the state.
