The Pros and Cons of
Business Entity Types For eCommerce

These days, it’s incredibly easy to start an eCommerce business. 

Whether you’re an Amazon FBA seller or selling your own wares on eBay, Shopify or Etsy, the abundance of selling platforms, DIY websites and social media networks allow just about anyone to start making money through selling stuff online.

It’s so easy, in fact, that a lot of eCommerce sellers are hit with an inconvenient truth when tax season rolls around: they haven’t spent any time thinking about the right type of business entity for their eCommerce business. 

Without having made this decision, they are lost in a sea of paperwork, doing their best to guess which forms are their responsibility, and hoping that they aren’t making a dire mistake that will cost them money down the road.  

Sole Proprietor

Being a sole proprietor means being one with your business, from a legal standpoint.  In other words, the law views your business as a legal extension of you personally. 

That means that your business risks are also personal risks—the sole proprietor entity offers your personal life no legal protection from the risks that come with running a business.

The upside of a sole proprietorship is that it’s a simple and uncomplicated entity, making it a great place to start when you’ve just got your eCommerce business up and running, or if you intend to keep it small (i.e., a side business where you earn a little extra income). 

You don’t have to register your business with the state or make a lot of decisions about how to file your taxes. You’ll just need to fill out a Schedule C on your personal tax return.

Special advice: Get an Employer Identification Number (or EIN for short) with the IRS for your sole proprietor business, rather than using your social security number.  This will protect your SSN from being public when you open financial accounts or execute legal documents.  You can apply for a free EIN with the IRS here.  

LLC/LLP

LLC stands for “limited liability company,” while LLP stands for “limited liability partnership.”  This type of entity is best for an eCommerce business owned by two or more people. 

The advantage of an LLC is that it keeps the risk of your business within the business—individuals’ personal lives are protected from any financial or legal issues that might arise within the business.

To set up your eCommerce business as an LLC, you have to register with the state where your business is located. If you’re doing business outside your state (as many eCommerce businesses do), you may be subjected to additional state taxes, as well. 

When filing your taxes, an LLC requires a separate tax return using partnership form 1065. This offers two-way protection.

Special advice: An LLC may petition the IRS to be taxed as different types of entities which can offer different tax benefits. To be taxed as a C-corp, you would file Form 8832. You can subsequently petition to be taxed as an S-corp by filing Form 2553.

C-Corporation

A C-Corp is a more complicated type of entity, but it’s beneficial for certain types of eCommerce businesses. You should consider filing as a C-Corp if:

  •   Your business includes many shareholders
  •   There are foreign owners
  •   The business needs to continue in existence regardless of shareholders entering or leaving
  •   The business needs to be able to raise equity capital
  •   The business needs to issue different classes of stock
  •   Shareholders desire corporate earnings to be taxed separately from their personal taxes
  •   Generous benefits packages are desired

The big issue to consider with a C-Corp is that it can potentially lead to double taxation, i.e., being taxed on both corporate income and shareholder dividends. 

It’s possible to minimize this issue if your business is service-oriented, this issue can be minimized through salaries. However, if the business is capital-intensive, its earnings may be too great to rely on salary to minimize dividends.

Special advice: Unless you have a special reason to set up as a C-Corp when starting your business, you’re better off using a different type of business entity. It’s much easier to “step up” to C-Corp status than to step down from it.     

S-Corporation

There is one reason to petition the IRS to be taxed as an S-Corp: to reduce self-employment taxes.  Since a corporation is considered a legal entity independent of the owners, its earnings are considered a return on investment, not as earned income. This means they are not subject to FICA or Medicare taxes.

To register as an S-Corp, though, your business has to meet a slew of requirements:

  •     Only 1 class of shareholders
  •     No more than 100 shareholders
  •     Shareholders must be US citizens
  •     Shareholders may not be other corporations or partnerships
  •     All shareholders must be treated equally regarding voting privileges and profit distributions
  •     Earnings pass-through to personal returns via K-1 statements

It’s important to note that the IRS requires any shareholder who owns more than 2% of an S-Corp and who works in the company to draw a “reasonable salary,” i.e., an amount that you could expect a third-party employer to pay you for doing the same work.

Special advice: The tax savings of an S-Corp only extend so far. When the share of total earnings per shareholder begins to exceed the FICA income cap (which was $132,900 in 2019), the advantage begins to decline.

Things To Consider On Where to Register Your Business Entity

 Each state has different rules regarding the handling and governance of businesses registered with their Secretary of State. Several states do not have business income or franchise taxes. Among these, Nevada also offers strong legal protections for owners and officers. Wyoming does not divulge the names of owners or officers of companies registered there. Delaware also has strong, pro-business laws and protections.

It’s a common misconception that you can establish your US-based business anywhere you like, and this is not the case.  Seek counsel from a CPA or Tax Accountant who specializes in your type of business to make sure the right state is chosen to establish your business entity.

The Bottom Line

Choosing a business entity for your eCommerce business is an important and strategic decision to make. Fortunately, it’s not a once-and-for-all decision. 

You can register as one type of business today, but change to a different type of entity as your business changes, your team grows, and your long-term vision expands. 

Working with a reliable Finance + Profit Pro —someone who is not only well-versed in legal and tax matters but also understands how small eCommerce businesses like yours can scale over time—you’ll know exactly what type of entity best suits your needs.

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