Ecommerce Know-How: Sole Proprietorship, S Corporation or LLC?

Launching an ecommerce business can be confusing. An entrepreneur must choose a shopping cart and find sources for inventory. And, there are questions regarding accounting, liability, and filing regulatory documents. Those questions can create enough confusion to halt the journey before it begins.

It doesn’t have to be that way.

For this “Ecommerce Know-How,” I asked Certified Public Accountant Ryan L. Ross about the quickest and most cost-effective ways to set up your ecommerce business, and get it off the ground.

A prospective business owner based in the U.S. has three choices when it comes to creating the new enterprise. He or she can create a sole proprietorship, an S corporation (the “S” refers to a subchapter of the U.S. Internal Revenue Code), or an LLC (limited liability company.) Taking no action will, by default, result in the creation of a sole proprietorship.

Sole Proprietorship

If you have no partners in your business then a sole proprietorship is an option for you. It is the simplest type of business to form and ensures that you will pay no corporate taxes. You will, however, pay taxes on all of the business profits, regardless of whether you distribute the money to yourself. In short, the government recognizes no distinction between you the business owner and you the individual.

The primary downside of sole proprietorship is risk. There is no legal distinction between you and the business. That means you are liable for all debts, and no protection exists for you personally in the event the company is sued.

S Corporation

An S corporation can be formed with one or numerous (up to 100) shareholders. An S corporation pays no income taxes. Shareholders report their pro-rata profits or losses on their individual income tax returns, similar to the reporting of profits by sole proprietors. But, with an S corporation, the government makes a clear distinction between the business and the individual.

Forming an S corporation limits your risk. If your business fails or becomes targeted in a lawsuit, it is your business and not yourself personally that will be held liable. Ross calls it, “The least expensive form of insurance you can buy.” There are limits on that protection, however, which we will discuss later.

Limited Liability Company

An LLC is not a corporation and therefore requires less paperwork and record keeping. One or more individuals can form a LLC (the individuals are called “members,” versus “shareholders”) and they are taxed according to their pro-rata ownership in the company.

As the name implies, an LLC limits your personal risk or liability. Like an S corporation, you are not, in most cases, personally liable should your business fail or become targeted in a legal action.

How You Should File

Businesses change with time. An ecommerce firm, for example, may start small (perfect for an LLC) and later grow to such a size that incorporating makes sense (an S corp.) However, since changing a business designation can be costly in terms of time and money, potential small business owners were, until a couple of years ago, encouraged to simply file as an S corp. and skip the LLC designation.

Due to changes in tax codes, Ross says he no longer recommends that course of action. He encourages small business owners to file as an LLC. If the business grows as hoped, Ross says it’s relatively simple to file an election to tax as an S corporation while remaining an LLC. Plus, as an LLC, you will not have deal with the legalities of holding regular board meetings.

Ross discourages the formation of a sole proprietorship for clients who plan to run a sustainable, growing business over the long term. The risk is just too great.

A Final Word About Liability

Virtually every kind of online business will have potential liability issues. The parent of a toddler could sue a toy seller, a furniture seller could be held liable for an injury caused by a broken chair, and a memorabilia dealer could face legal action if an item is deemed to be a fake. That’s why Ross advises his clients to purchase insurance for their business.

Creating an LLC or S corp. will protect you, the individual, financially. But there are caveats: “The corporate veil” can be pierced in cases of gross negligence or fraud, or in the instances of slopping record keeping that co-mingles personal and business affairs. Under those circumstances the individual can be held liable for damages.

Summing Up

The complexities of forming a business should not be a barrier to entry. That’s because, as Ross stressed, it’s not that complicated. Meet with an accountant about your particular needs, file your business online via the secretary of state’s website, and (particularly if there is more than one owner in your company) consult an attorney. And then get to work.

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Kevin Patrick Allen
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