You are probably in the process of registering company’s name and getting an EIN. Maybe you even got to working out the details of your website design, business model, marketing, SEO, finance, services, drop shipping, and more. Or maybe, you don’t have a single thing ready and are bombarded with all the accounting, liability, and regulatory documents that you need before you open an ecommerce store. But soon or later, you’ll need to decide upon a legal structure for your business. In the US, you are given three wonderful&delightful choices when it comes to creating a new business structure, which are sole proprietorship, S Corporation or LLC. you’ll be automatically considered sole proprietorship by IRS if you don’t decide (ROAR). As an individual, you can choose to either operate as a sole proprietor or LLC (do LLC brothers and sisters if you can). S corporation is an option, but this includes shareholders and it involves too much work and money for someone starting off in the online business world. Corporation is good if you don’t want to be personally liable, since it’s considered the lowest form of insurance you can buy besides LLC.
Why is it important to choose your business structure properly in the beginning when you can change it down the road? Ecommerce firm may face changing business designation, which can be costly in terms of time and money. Back in the days, when people thought your company will do well, people will encourage you to file as S Corp and skip the LLC designation. However, in a world of ever changing world that’s unpredictable, it’s simpler to file as LLC. If the business grows as hoped, it’s simple to file tax as S corporation while remaining as LLC thanks to the changes in the tax code, or vice versa as a sole proprietorship. Plus, LLC doesn’t have to deal with holding regular board meetings and other legalities and can be considered both a corporation or sole Proprietor depending on how you file the tax (new tax code YAY!). So how much does this usually cost? LLC differs by State and also has different requirements like publishing your name on the paper, it can be around 250 dollars in Georgia while New York can go up to1250 dollars easily. LLC would be good if you think your company has a chance of getting sued (since you can file as corporation and avoid ruining your credit and personal asset), while Sole Proprietorship may not be. If you think this is too much work to do yourself, you can always hire someone to file LLC for you, in which they may charge you 50 dollars (but don’t… seriously… it’s easy).
A sole proprietorship is the simplest business structure and the cheapest (it’s free). In fact, you may already own one without knowing it. If you are a blogger for example, you are a sole proprietor. You do not need to register your business name with the state (as long as the company name has your last name in it, for example, bob’s blog //you can own a website asdfdasf.com and put owned by bob’s blog at the bottom//) and you can use your social security number instead of obtaining an employer identification number (if you want an EIN, you can easily get one on IRS website even as a sole proprietor).
You however, need to take responsibility for all the debts, losses, and liabilities. You also need to make sure you have all the necessary licenses, permits, and registrations. This vary by industry, state and locality. You should use the proper tools to find a listing/checklist of the items you need to run your business. If you choose to operate under a name different than your own, you’ll need to get DBA. Because there is unlimited personal liability, the risk is high. You also can’t sell stocks and raise money unlike corporations (LLC can’t either). Lastly, this may come with a heavy burden, as you alone are ultimately responsible for the business.
So, let’s jump into taxes for sole proprietor. Since you and the business are the same, business itself is not taxed separately. This means that the money you make from the company is your income, and your losses, expenses, or revenue is reported on schedule C on the standard form 1040. You have to make sure you withhold enough pay for the income taxes, so the IRS won’t charge you fine (I believe its 86 dollars every month, maximum of 12 months, they can charge you as a penalty for not paying them on time). This have many disadvantages, because there are a lot of tax benefits that you can get with corporations and LLC that you can’t get as sole proprietorship (but this may be good if you are just starting off small in the online industry and aren’t earning that much or spending that much).
Advantages of sole proprietorship is it’s easy to form, since all you need are legal costs limited to obtaining the necessary licenses, permits, and registration, complete control, and easy tax preparation (some may say that the tax rates are the lowest of the business structures, which is true, but there aren’t as many tax breaks as you would get with other structures).
Now onto LLC, which is a really great business structure. Instead of shareholders, you have members. LLC is not a corporation and requires less paper work and record keeping. LLC is great because you can choose what you want it to be for the tax season (make it like a sole proprietorship or like a corporation, depending on how you want to file the tax). Net effect of taxation will be identical if you were single member LLC (which is technically sole proprietor) or a sole proprietor, so don’t worry about calculating the difference. You will also use 1040 schedule C if you use the first option while operating under LLC. If you establish LLC, you must first create an operating agreement and register with your secretary of state’s department. You would need to pay a fee and file an introductory form called articles of organization. DBA is required if you choose a name that is different from yours, which will probably be the case. Also, you may also need to apply for a federal and state EIN, if you don’t choose to make it sole proprietorship on certain years. Also remember that Limited liability entities do not shield you from lawsuits based on issues other than debt.
Your online retail business will owe sales tax for sales to in state customers, your structure should not make any difference in how you pay this tax to the state. The only added expense for LLC is the startup fees and annual registration fees owed to the state.
Neither LLCs nor sole proprietorships are required to hold board meetings, as are nonprofit organizations and corporations. Both business types may be required to report quarterly or monthly sales, depending on your secretary of state requirements. LLCs are required by the state to file an annual report, with an accompanying fee, to let the state know you are still in business. All other accounting and records will be identical for your online business, regardless of the type.
If you expect to grow in the future (I’m talking about short term), which means hiring employees, it’d be better to establish a LLC from the start and amend it in the future to accommodate it down the road. Sole proprietorship on the other hand will be perfect if you plan to work by yourself for a while, since you can re-establish your company into LLC down the road (which means possible name change and so on).
Things to consider are legal (LLC means your personal liability is limited when you are sued, so your house won’t be taken away), credibility with your customers (having a registered name means they have greater sense of security, knowing you are registered with the state and less likely to disappear with their money), name protection (LLC name can’t be taken by anyone else since it’s registered by the state, but you can do this with sole-proprietorship too by getting DBA), and lastly operating agreement (you must register closure with the state and distribute all assets as outlined in the agreement).
Also, think about signing up for insurance. Online business will have potential liability issues, such as a toy seller, possibly becoming liable for a toddler getting hurt by a toy. Remember the nebulous concept of ‘nexus’ which is interpreted differently in each state but the idea is that your business can be registered anywhere you want, but it’s the place where you physically operate the business that dictates your tax jurisdiction, among other things. This concept is very important for online business owner.
For example, you may have servers in one state and clients in another, but if you are sitting in a chair in Georgia operating your server and doing work for your clients, the state of Georgia can say that you have nexus in their state and obligate you to register your business and pay the required taxes/license/permits/etc there. This would mean you have a foreign entity, which would probably cost you more than just registering in Georgia in the first place. There are many cases where an out-of-state registration works very well – for privacy, reducing taxes, etc. but those things need some additional planning and are harder to pull for very small businesses. Each state is slightly different, check the information in your state before moving forward. But that’s the idea.
I’d like to talk a lot more about this subject, but I’ve already jumped back and forth all over the place in this article. I think that it’s best for you to do more research on your own before you jump in and create your structure.
Following below are some good links to help you understand more about the subjects I’ve gathered. I suggest you talking about it in forums or reddit, maybe even go join a seminar and work part time for ecommerce owner and learn from them!http://www.nolo.com/legal-encyclopedia/50-state-guide-establishing-sole-proprietorship.html