Few decisions will have as big of an impact on the taxes you pay and regulations you must follow as the business structure of your online company. When starting an online business, you should strongly consider consulting with a lawyer for advice as to the best structure. However, you can do some in-depth research beforehand on the topic to get a better feel for the options.
Remember, the following information is not to replace legal advice, merely to help you better understand your options in advance of the decision making process.
Many small online businesses opt for a sole proprietorship as this is the simplest of the business structure options. Typically, this involves a single person who owns and operates the business. Since your expenses and business income go on Form 1040 of your personal income tax return, and profits and losses on Schedule C, this particular structure has some tax benefits.
Because of the way the Schedule C incorporates into your personal tax return, business losses can offset other earned income. Sole proprietors must also file Schedule SE and self-employment tax, and they need to make payments of estimated tax if they owe a minimum of $1,000 in federal taxes.
Sole proprietorship comes with a few disadvantages as well, including the fact that you have 100 percent responsibility for any liabilities related to the company. As a result, it puts your assets at risk. It can also make it more difficult to secure business loans, meaning you would likely need to depend on your savings or home equity.
Corporations are independent legal entities fully separate from owners. Because of this, there are additional tax requirements and regulations. With liability protection, an owner has no responsibility for the debt of the corporation, giving this business structure a significant advantage over others. Corporations also have an easier time raising money through the sale of stock. It is even possible for corporations to continue indefinitely.
The biggest downside of a Corp business structure is the high cost and the legal complications involved. Keep in mind that every state has its unique laws and regulations. As such, you will likely need to hire an attorney to create your corporation. You also need professional tax preparation and auditing services to meet the regulations. It is also important to note that, if your corporation is small and you are the sole owner, you may pay additional taxes on your earnings – once as corporate income and again as personal income on your own taxes.
S-Corps or S corporations are better for small businesses that corporations, whether online or brick and mortar. This comes from the combination of liability protection and some tax benefits. With the S-corp business structure, losses and income end up on shareholders’ individual tax returns, meaning there is no double payment of taxes as with corporations. S corporations without inventory can even opt for the simpler cash accounting method. Because S corporations can have up to 100 shareholders, it is easier to secure capital.
In terms of downsides, S-corps have many of the same regulations and laws as corporations, meaning higher costs for legal and tax preparation fees. They also require minute taking, shareholder voting, director and shareholder meetings, and incorporation article filing.
Limited Liability Company (LLC)
Limited liability companies have only recently become popular among small business owners and entrepreneurs. This business structure combines the benefits of corporations with partnerships. LLCs provide liability protection without double taxation. Additionally, losses and earnings go on the owners’ personal tax returns. The big difference between an S-corp and LLC is in benefits. With LLCs, there is no limit for the number of shareholders, and all members or owners can have full participatory roles.
It is important to note that LLCs do not include perpetual statuses, with some states having a limit of 30 years. Because of variations in how states treat LLCs, ecommerce platforms operating in more than one state may find them somewhat complicated. If you choose to use an LLC, you need to hire an experienced accountant, someone familiar with the unique regulations related to this business structure.
Choosing the Right Structure
The business structure you select for your online business will impact everything from taxes to how financial losses can impact your life. Each business structure has a unique set of advantages and disadvantages. Choose the one that works best for your specific company.