Save Money and Protect Your Assets with the Right Legal Structure for your e-Commerce Business.

Choosing the right business structure is an important decision. The right choice can save you a lot of money (and a lot of headaches). The wrong choice can be costly in more ways than one.

These are the different legal structures under which you can choose to operate your eCommerce business:

• Sole proprietorship.
• Partnership.
• S-corporation.
• C-corporation.
• Limited liability company (LLC).
• Non-profit corporation.

In this post, we’re going to give you a brief overview of each so that you’ll be in a better position to choose the right one for your business.

(Un)Limited liability

Before we talk about the different entity types, let’s have a quick lesson on liability. While there are many reasons to choose one structure over another, liability is one of the more important ones.

“Liability” simply means that depending on the type of business you set up, you, as an individual, may or may not be liable for any losses that the business incurs.

Say a product you sell injures a customer, who sues you for negligence. You lose, and the customer is awarded a million dollars. Without the right business structure in place, that money could potentially be taken out of your personal assets, such as your savings or your home. Similarly, if your eCommerce business fails while owing money to various creditors, the money owed could be collected from your personal assets.



Liability isn’t the only reason to choose one structure over another, but it’s very important to take into consideration!

Sole Proprietorship

Sole proprietorships are the simplest and most common form of business and do not require any formal action to set up. All you have to do is obtain whatever licenses and permits are required by your area and industry and get to work.

For income tax purposes, the government treats you and your sole proprietorship as one. If you incur a loss in your sole proprietorship, that loss carries over to your personal tax return to help offset income from employment and investment income. In the early years of a business when losses may be incurred due to start-up costs, this can be beneficial because it can result in significant tax savings.

One of the main drawbacks is that the owner must pay self-employment taxes on the entire net profit of their business.

Another major disadvantage of the sole proprietorship is that you have unlimited personal liability. You can lessen the risk of liability in the case of physical or personal injury by obtaining proper insurance coverage.

Finally, the business cannot be sold or passed on to heirs. If you die, it simply ceases to exist. On the other hand, no formal dissolution is required if you no longer want to have that business.

Finally, the business cannot be sold or passed on to heirs. If you die, it simply ceases to exist. On the other hand, no formal dissolution is required if you no longer want to have that business.

Advantages:

• Fast and easy to form. 
• Least expensive to set up.
• Complete control.
• Easy to dissolve.

Disadvantages:

• Higher self-employment tax (compared to S-corporations).
• Unlimited personal liability.
• Cannot be sold as a business.
• Dissolves with owner’s death.

Partnerships

A partnership has two or more owners but is otherwise very similar to a sole proprietorship. No written documents or other formalities are necessary for most partnerships, but it’s smart to have contracts in place spelling out what each partner will contribute, who will be responsible for what duties, and how and when profits and losses will be divided.

Every partnership must have at least one “general partner,” who is active in the business. “Limited partners” are essentially investors, who are not active in the business and whose liability is limited.

For income tax purposes, the profits or losses from a partnership are treated as ordinary income or losses. Similar to the sole proprietorship, you can offset losses in the partnership to income generated from other sources of income, resulting in considerable tax savings.

Liability remains an issue, though. If the business can’t pay off its debts, creditors can satisfy their claims out of any general partner’s personal assets. In addition, when any partner fails to pay personal debts, creditors may satisfy their claims out of that individual’s interest in the business.



Needless to say, this type of partnership requires a great deal of trust and respect between partners. 

Advantages:

• Easy to form.
• Inexpensive to set up (though we suggest a lawyer to draw up an agreement between partners).
• Tax savings.
• Easy to dissolve.

Disadvantages:

• Unlimited liability.
• Dissolves on the death or withdrawal of one or more general partners.
• Disagreements between partners can be very damaging.

C-CORPORATIONS

A corporation is a legal entity with a separate legal and tax life distinct from its shareholders. The label “C-corporation” simply refers to a regular, state-formed corporation.

A corporation issues shares of its stock as evidence of ownership to people who contribute money or business assets. Thus, the stockholders (also known as shareholders) are the owners of the corporation and are entitled to any dividends the corporation pays. In the event of a dissolution or liquidation, the shareholders receive the corporation assets after all creditors have been paid.

Unlike a partnership or sole proprietorship, a corporation is capable of continuing indefinitely and can be sold or passed on to other owners.

A corporation is required to have a board of directors, corporate officers, and annual shareholders meetings, and setting one up is more complicated than creating a partnership or sole proprietorship. You’ll need to file Articles of Incorporation with your secretary of state and pay the necessary state fees and taxes.

As a separate legal entity, a corporation is responsible for its own debts, meaning that shareholders, directors, and officers are not personally responsible for corporate liabilities. There are exceptions to this, such as when a shareholder has personally guaranteed a loan, but limited liability is one of the big advantages of this business structure.

In addition, lenders are generally more willing to make loans to a corporation that has been operating successfully than to a sole proprietorship or a partnership. The corporation also has the ability to raise capital by selling shares of its stock.

Employees of C-corporations can be eligible for benefits not available to self-employed people such as sick pay, group life insurance, accident and health insurance, and corporate pension plans.

Unlike sole proprietorships and partnerships, when your corporation loses money, such losses remain within the corporation and no immediate benefit is derived from the potential offset against earned income. In such cases, the losses will be carried back for two years and then if any losses still remain, they can be carried forward for up to twenty years as “net operating losses” to offset the taxable income and hence reduce the corporate tax in those years.



Another potential disadvantage of a corporation is “double taxation.” The corporation pays tax once based on its corporate profits, and you as shareholder pay taxes as ordinary income when profits are distributed to you.

Advantages of corporations:

• Limited liability.
• Ability to raise capital.
• Permanence of existence.
• Employee benefits.

Disadvantages:

• Expensive and complicated to set up.
• Corporate formalities.
• Inability to take losses as deductions.
• Double taxation.

S-CORPORATIONS

Setting up your business as an S-corporation alleviates the “double taxation” issue of C-corporations. An S-corporation begins as a general corporation (C-corporation) or a Limited Liability Company (LLC). After the C-corporation or LLC has been formed and assuming it meets the requirements of the IRS, you may elect “S-corporation status” by submitting IRS form 2553 to the Internal Revenue Service.

Note: In some cases, a state filing is required as well; be sure to check for your state as being taxed as an S-corporation on the federal level and a C-corporation at the state level may put you at a tax disadvantage.

Once a business becomes an S-corporation, profits and losses are passed through the corporation and are reported on the individual tax returns of the respective shareholders of the S-corporation. Thus, the key distinction of the S-corporation is that profits and losses are not taxed at the corporate/business level like they would be if the corporation remained as a C-corporation.

If a corporation claims income from a passive investment (e.g., real estate) for three consecutive years, and if that income exceeds 25% of the corporation’s gross receipts, S-corporation status may be terminated by the IRS. Most real estate investors, for example, prefer placing real property in an LLC (Limited Liability Company) rather than an S-corporation for this very reason.

One of the major benefits of an S-Corporation is savings on self-employment taxes. An S-corporation owner can choose to receive both salary and dividend payments from the corporation. Because dividends are not subject to self-employment tax, this can result in lower taxes. The S-corporation can also deduct the cost of wages paid when calculating the amount of income that is passed through to shareholders.

Watch out, though: the IRS keeps a close eye on these types of transactions. If it determines that the division between salary and dividends is not “reasonable”—for example, if you’re paying yourself a tiny salary and taking most of your money as dividends—it may re-characterize the income.



Your decision to be an S-corporation isn’t permanent. If you later find there are tax advantages to being a regular corporation, you can easily drop your S-corporation status.

Advantages:

• Limited liability.
• Avoids double-taxation.
• Self-employment tax savings.
• Continuity of existence.
• Employee benefits.

Disadvantages:

• Corporate formalities.
• Lack of flexibility.
• Minimum state corporate tax: Some states require all S-corporations to pay a minimum corporate tax even if the business reports a loss.

Limited Liability Company (LLC)

An LLC consists of one or more “persons” (meaning an individual, general partnership, association, trust, estate, or corporation) and is a kind of hybrid between a partnership and a corporation. It combines the “pass-through” treatment of a partnership with the favorable limited liability accorded to corporate shareholders.

LLCs offer more generous loss deductions than S-corporations, allow more classes of ownership (such as voting and non-voting), have more freedom in deciding how profits and losses are to be divided, and are not bound by the same shareholder limitations imposed by the IRS.

However, the paperwork for forming the LLC needs to be completed meticulously. The articles of organization must specify the date on which the LLC’s existence will terminate. Otherwise, an LLC may be dissolved at the death, withdrawal, resignation, expulsion, or bankruptcy of a member.



Should members of an LLC desire additional self-employment tax savings, they can elect to change its tax status to that of a regular or S-corporation.

Advantages:

• Limited liability.
• Flexibility.

Disadvantages:

• Higher self-employment tax compared to an S-corporation.
• Unreliable continuity of existence.

Nonprofit Corporations

A nonprofit organization is created for purposes other than generating profit and has no part of its income distributed to its members, directors, or officers. Nonprofit organizations must be designated as nonprofit when created and may only pursue purposes permitted by statutes for nonprofit organizations.

Articles of Incorporation must be prepared and filed with the appropriate state entity. In addition, bylaws must be prepared, minutes must be maintained, and certain federal and state tax-exemption filings must be filed to attain a tax-exempt status.

A nonprofit corporation, like a for-profit corporation, is an entity with a perpetual existence that may outlive all of its founders. In addition, the corporation can act like an individual, entering into contracts, incurring debt, and owning property.

Directors, trustees, and officers of nonprofit corporations are usually afforded limited liability status. However, state and federal governments have the power to hold corporate officers and directors personally liable for the reporting and payment of taxes. 



Nonprofit corporations cannot issue shares or pay dividends, but they are eligible for certain federal and state tax exemptions. With proper planning and filing, your nonprofit corporation should be exempt from certain taxes, but your corporation may still be required to file informational returns and annual reports to the state and federal governments and is responsible for employee withholding taxes.

Advantages:

• Separate and perpetual existence.
• Employee benefits.
• Limited liability for members and directors.
• Discounted rates from some organizations/lower postal rates for bulk mail.
• Employees may qualify for job-training and other work-study programs subsidized by the federal government.

Disadvantages:

• Complex formalities and record-keeping.

Final Thoughts

Ideally, of course, you’ll know which type of business entity is best for your e-Commerce business when you start out. But that doesn’t mean you can’t change it if it becomes advantageous to do so later.



It is smart to review your situation with your CPA annually to ensure that your current business structure is still the best. A CPA who specializes in e-Commerce businesses will be able to help you decide which entity is right for you.