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Suppose you have a very small business that is entirely web-based – no physical assets or presence anywhere, the entire business is on the web.

You site’s revenue comes entirely from affiliate programs, drop shipping, or Adsense, so you don’t have a “warehouse” (even in your garage) or other presence.

If you live in a high-tax state like New York or California, can you form an LLC in a zero-tax state and avoid state income tax? Probably not. Here’s why: Remember that LLCs are pass-through entities, meaning that the LLC doesn’t pay taxes.

Yes, it files a tax return (unless its a single member LLC, in which case its combined with your regular 1040), but that’s only for calculating the taxable income. You pay your LLC’s taxes personally.

This is an advantage over a corporation, because a corporation pays taxes on its own income, and then when it pays you a dividend, you pay taxes on the dividend. That’s what accountants and tax lawyers are referring to when they speak of double-taxation of a corporation.

Suppose that you live in California, and run a web-only business. You could form an LLC in a state with no income tax, such as Florida or Texas.

The problem is, when it came time to pay taxes, the LLC’s income would be reported on your tax return. So you’d end up paying California tax anyway. The only way to avoid California tax on your business would be to form an LLC in a zero-tax state such as Texas, but have your LLC taxed as a corporation.

Your LLC would be corporate tax on its income, but it would not be subject to California state tax. The only portion that would be subject to California tax would be whatever you, as a California resident, received in dividends.

However, unless you’re leaving money in the company, presumably all of your profits would be paid as dividends. The bottom line is, in attempting to avoid California tax, you end up paying the corporate double tax.

If you attempt to leave money in the LLC year after year, and not pay it out in order to avoid state and dividend taxes, you will run into a massively complicated area of tax law involving excess accumulations and all kinds of stuff that only specialized tax attorneys deal with and you really don’t want to venture down that road at all.

The best tax avoidance strategy with your corporation is to ensure that every expense possibly related to your business is deducted. That will lower your taxes tremendously. As a business owner, you can deduct expenses that no employee can.

You can deduct business travel, including all car mileage associated with your business. Did you drive to the store to buy a computer to run your site? Deduct the computer, and the mileage associated with the trip to the store.

Generally, your best bet for lowest cost and least complication is to incorporate your LLC in the state where you live. Also, the best tax minimization idea is not incorporating in Nevada, Texas, Florida or Wyoming (unless you live there, of course), but to maximize all your legitimate deductions. Instead of spending money incorporating in far-flung states, your best bet is to incorporate in your own state.

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