Should an e-commerce business file for incorporation? The short answer is yes.
It is possible to run an e-commerce business as an unregistered entity. This is a default business formation known as a sole proprietorship. Entrepreneurs can start and run businesses structured as sole proprietorships particularly if the business is one with limited growth potential and low overhead expenses. Over time, however, they may choose to form an LLC or incorporate as another registered entity. Doing so often means making a decision that better accommodates the growing business and its needs.
Which entity should an e-commerce business incorporate as? Here are some of the most popular options:
- Sole Proprietorship
- Limited Liability Company (LLC)
- S Corporation
Ideal fit: Online merchants or e-commerce storefronts that operate as low-risk ventures or as a hobby.
Small businesses start off as sole proprietorships: unincorporated businesses that are not considered to be legal entities. The structure of a sole proprietorship has no barriers to entry. Little to no paperwork is necessary to start the business. There are no ongoing maintenance requirements. Essentially, as soon as you begin acting as a business you are a sole proprietorship. The owner is able to exercise full control over the company.
Which types of e-commerce businesses can, or should, be sole proprietorships? The answer is very small businesses. We’re talking so small they are technically considered to be hobbies. A few businesses may include photography, writing, exercise instruction, and tutoring. The business may have a small customer base, but again it must be as low-risk as possible.
Most businesses do not stay this small forever. Gradually, a hobby will expand its offerings and increase its customer base. Once the hobby begins to earn a profit and you report this income to the IRS, the hobby is no longer considered a hobby. It is now a sole proprietorship because it engages in business activity.
From here on out, entrepreneurs may choose to remain a sole proprietor or form a registered business. If the business continues to expand and isn’t limited in growth, its best bet will be to incorporate. This ensures the business, and its owner, receives limited liability protection. Having this type of legal distinction keeps professional and personal assets separate. It also takes a load off the merchant’s shoulders in terms of responsibilities. A sole proprietor is responsible for all aspects of the business and any liabilities. Incorporating allows sole proprietors to treat the business as a separate legal entity and lessen the responsibility load.
Ideal fit: E-commerce businesses and startups that would like to receive asset protection and save on taxes.
We cheated a little bit by mentioning an S Corporation because an S Corp is technically not a legal entity. Rather, an e-commerce business may elect S Corp status for tax purposes. Doing so allows the business to receive pass-through taxation. Profits pass through the company level and the business owner can avoid double taxation. Business owners may also put themselves on payroll as an S Corporation and pay themselves a reasonable salary to save on FICA taxes. You’ll also receive limited liability protection as an S Corp.
The only type of e-commerce business that isn’t well suited for an S Corporation is a high-earning company. These types of businesses may be better suited to incorporate as a corporation.
Limited Liability Company (LLC)
Ideal fit: Online merchants or e-commerce storefronts with serious plans to grow their offerings and business.
Many eCommerce business owners or merchants may have plans to expand their business beyond its online presence. For example, they may wish to open a brick-and-mortar storefront. An in-person storefront will allow them to sell offerings in-person in addition to keeping their online presence up and running. Their best bet is to form a limited liability company (LLC).
Forming an LLC allows entrepreneurs to form a credible, flexible business. An LLC can quickly build credibility with consumers and become a respected brand. The entity receives limited liability protection for its professional and personal assets. Owners of the LLC, known as members, may choose an LLC structure that best suits their needs in terms of exercising control over the business. (Think structures like member-managed that allow all members to equally run the LLC.) The flexible nature of an LLC also allows the entity to determine how it would like to be taxed, too.
These business expansion plans may grow over time. Perhaps one day the e-commerce business will decide it wants to expand globally or offer an IPO. If that’s the case, the owner will change the LLC entity formation to a corporation. But that’s later down the line — when and if the e-commerce business decides to take on the world!