You’re ready to start your e-commerce business. You’ve written your business plan, selected the products that you’d like to sell, and have vendors and investors who are ready to move. But you still have one major consideration — should you form an entity for your ecommerce business?
In short, the answer is ‘yes’. However, there are several steps involved in business entity formation that you should know about. Many of these steps will have long-term consequences for your business and should be made carefully. Here are the general steps you need to follow to set your internet business entity.
Types of Business Entities
First, you’ll need to decide which structure is best for your business. Here are the options that you’ll most likely choose for your e-commerce business:
- Sole Proprietorship. A sole proprietorship involves a single person or married couple in business alone. While this type of business structure offers greater flexibility, it has many drawbacks. One main drawback is making the owner personally liable for all debts incurred by the business.
- Partnership. A partnership consists of two or more persons who agree to contribute to a business. Each partner shares in the profits, losses, and management of the business.
- Corporation. A corporation is a more complex business structure which can offer many tax and financial benefits.
- Limited Liability Company (LLC). An LLC is formed through a special written agreement. The agreement outlines the organization of the LLC, including provisions for the management, assignability of interests, and distributions of profits and losses.
Among these types, the most popular structures for e-commerce businesses are a limited liability company (LLC) and a corporation.
LLC vs Corporation – Differences & Benefits
Here are pros and cons of LLC versus corporations:
In both an LLC and a corporation, there is no limit on the type or number of owners of the entity. In contrast, in an S corporation, there are limits on the type and number of owners, namely S corporations can’t have more than 100 owners, and the owners cannot be “non-resident aliens.” LLC owners are considered to be self-employed which means that they must pay self-employment tax on their net earnings from the business.
Corporations have a more set management structure. They have appointed directors who oversee the major business decisions and officers who are responsible for the day-to-day management of the company. The board of directors, as they are often referred to in organizational documents, are elected by the shareholders at formal meetings. These meetings are documented in meeting minutes.
LLCs, on the other hand, do not have the same formal structure when it comes to management. LLC’s are run by managing members who are explicitly mentioned in the organization documents. These documents can be edited at any time.
Corporations and LLCs also have the option of filing taxes as a C corporation and filing as an S corporation. An S corporation is considered as a “pass-through entity,” which means the business itself isn’t taxed. Instead, you will report the income that the business earns on your personal tax returns. A C-Corporation will be taxed and then dividends that are passed on to the shareholders are taxed again. This concept is known as “Double Taxation” and one reason C-Corporations are not the most tax efficient structure for small business owners.
Top Reasons to Form an Entity for Your Business
You may be tempted to operate your business as a sole proprietorship. However, operating as a sole proprietor does not offer you any liability protection. That means that if someone sues you, your personal assets are at risk and you could lose everything.
When you form an entity for your business, you not only get liability protection, you’ll also have the opportunity to build credit for your business. With a business credit profile that is separate from your personal credit, you can get access to more favorable loan terms and pricing when it comes to purchasing inventory and equipment for your business.
Finally, the tax and accounting process for your business will go a lot smoother. When you form an entity for your business, you’ll be required to maintain separate accounting records. That means that you’ll also have separate business accounts for your banking and other business related activities which makes it a lot easier to pull records of your transactions at tax time.
These Are the Most Business Friendly States
After you’ve selected the appropriate structure for your e-commerce business, you’ll also need to decide on a location for your business. While you might decide to just choose the state where you live to start your online business, you might be surprised to find other states, in fact, offer a more business friendly climate which can benefit your business significantly when it comes to taxes.
Every year, The Tax Foundation, an independent tax policy nonprofit, issues a State Business Tax Climate Index which enables business leaders, government policymakers, and taxpayers to gauge how their states’ tax systems compare. For 2017, the top 10 best states were:
- South Dakota
- New Hampshire
The reason why these states top the list is because they don’t levy at least one or more of the major taxes: corporate income tax, individual income tax, or sales tax.
However, Delaware and Nevada consistently rank as the top states to do business. Delaware is the best state for incorporating and forming an LLC in the United States because of the many protections that are offered by Delaware’s laws and courts. The personal assets of company owners are protected under what has been documented as Delaware’s proven asset protection shield.
Nevada is also a great state to do business in because there is no state sales tax. When you sell online, not having to pay sales tax could save you thousands if not more every year.
For the majority of small businesses, the best solution is simply to file the formation documents in the state where you’re located. By doing this, you’ll avoid having to pay registration costs in your home state in addition to having to hire an out-of-state registered agent. However, if your business will have significant activity nationwide or you want to raise venture capital, you might want to consider incorporating in Delaware.
Choose a Name for Your Business
It’s worth considering that you’ll also need to set aside time to choose a unique name for your e-commerce business to minimize the chances that the name will be taken by another business. You’ll also need to make sure that the name that you choose is in compliance with state law requirements that a new corporation or LLC name be different than all of the other entity names that are registered in your state.
You should also check with your city or county to determine if you are required to register a fictitious business name or DBA.
File Your Business Formation Papers
The steps to filling your business formation papers vary depending on the business structure and the state. Contact the state agency that handles business filings for more information. You’ll have to pay a filing fee. Once your documents are accepted by the state, you’ll receive a certificate that confirms that your new business entity exists.