Once you’ve decided to start your e-commerce business, you’ll have plenty of details to hash out, including finances, marketing, online store design, search engine optimization, customer service, production, shipping, and more. You’ll also need to choose your business’s legal structure; you’ll have a few options as an individual. The two most popular are an LLC (limited liability company) and a sole proprietorship. You’ll need to start an LLC or partnership if you have another member/manager for your online business.
What is an LLC?
LLCs are governed under state statutes. Consequently, the regulations governing them vary by state. LLC owners are known as “members”. Most states don’t have ownership restrictions, meaning anyone can start an LLC, including corporations, foreign entities, and other LLCs. Individuals (including non-US citizens and foreigners) may also start an LLC. A few entities have additional federal regulations, including banks and insurance companies, which prevent them from opening LLCs.
An LLC is a formal business structure requiring Articles of Organization to be filed with the state government; an LLC is more flexible and provides additional protections than corporations and sole proprietorships.
LLCs can elect not to pay federal taxes. Instead, profits and losses are reported via personal tax returns. LLCs may select a different tax class and be treated as an S-corp for tax purposes. If fraud is suspected or a company fails to meet its legal and reporting obligations, creditors may be able to go after its members.
Forming an LLC
The first thing owners need to do is choose a business name; once the business name has been verified as available, the articles of organization are the next step. Though the process varies by state, some core components don’t change. This article establishes the LLC members’ rights, powers, duties, obligations, and liabilities.
The articles of organization are filed, and a fee is paid to the state. You may pay paperwork and extra costs to obtain related requirements, such as an employer identification number (EIN), also known as a federal tax ID. Other information registered will include the LLC member’s names and addresses, the LLC registered agent, and the business statement of purpose.
What is a sole proprietorship?
You and your business are inextricable in the eyes of the law. A sole proprietorship is an unincorporated business entity; the individual owner is the sole proprietor. As the sole proprietor of a business, you’re personally liable for everything associated with the company. Thus, there’s no personal liability protection.
Your business transactions (such as business bank accounts, debts, and lawsuits) are treated the same way as personal debts. Sole proprietors make every decision, including how long they own the company and when they’ll sell it. With complete ownership of the business, they can operate it how they want. The term “sole proprietor” may be interchangeable with a “sole trader” or “individual entrepreneur”.
Registering a sole proprietorship
Although you won’t require business licenses, other matters require registration. Of course, the items you’ll need to register depend on your state; the state may require you to show business documentation for name registration. If your business has an assumed or fictitious name, you’ll need to register for a DBA (doing business as). If you have several DBAs, they’ll all operate under one social security number – the owners. Some proprietors will need an EIN/Federal Tax ID if they have employees.
Even if you don’t require an EIN, you can elect to have one, as some clients may want a business to provide an identifying number. The clients will use it for issuing 1099s at year-end; applying for an EIN can be done with the IRS for free.
LLC vs. sole proprietor startup
LLCs and sole proprietorships are popular options for small businesses. Most states have online LLC forms for the creation of LLCs. A sole proprietorship is a simple structure – you don’t need to register your business name, and you can use your SSN instead of obtaining an employer identification number.
If you establish an LLC, you’ll need to create an operating agreement if you have more than one member. Then you’ll need to complete the online registration with your Secretary of State department and pay a fee before registering your articles of organization. You may be asked to apply for a federal and state EIN, or you may be able to operate under your SSN for a single-member LLC. You’ll need to research your state’s requirements on your Secretary of State’s website; no matter your online business, you’ll need to obtain the appropriate business licenses from the state.
Finances and taxes
The effect of taxation will be identical whether you’re a sole proprietor or single-member LLC – your federal income is reported on IRS tax form 1040, schedule C. You’ll be taxed only once, as opposed to incorporated business owners who are taxed at the corporate level and at an individual level. Most banks treat limited liability companies and sole proprietors similarly, but you should clarify this with your financial institution first.
If your online retail business pays the sales tax, there won’t be any difference in how you pay taxes to the state; the only extra expense for LLCs is startup fees and annual state registration fees.
Records, reports, and meetings
Neither sole proprietorships nor LLCs are required to hold board meetings; nonprofit organizations and corporations are required to hold board meetings and retain additional records. LLCs are only required to file an annual report with an accompanying fee to let the state know their business is operating. All other records and accounting will be identical for your online retail business, regardless of your business type.
Room to grow
If you need room to grow and anticipate hiring employees, adding payroll, or additional managers, it might be better to establish an LLC from the start. In contrast, your initial operating agreement will establish your LLC as a single-member LLC; you’ll need to amend it to accommodate future growth. A sole proprietorship has no room to grow. However, you can later restructure your sole proprietorship by registering as an LLC.
The initials next to your business name (”LLC”) may give you extra credibility with more customers; they’ll have a greater sense of security knowing you’re a legitimate business owner that is registered with the state and unlikely to disappear with their investment. Moreover, the words “limited liability” infer high levels of personal protection. For example, your personal assets (such as your home, car, etc.) aren’t up for grabs in a lawsuit.
LLCs are also used to protect business names; business names can’t be taken by anyone else once registered by the state.
If you close your business, a sole proprietor doesn’t have any procedure or forms to complete/follow; an LLC manager must register the closure and distribute all assets as outlined in the agreement.
The product you’re selling may also impact how much liability protection you need. If you’re selling clothing, you are unlikely to need liability protection. If you’re selling health supplements, you take a greater risk when selling online and would likely want more protection. If you’re insistent on setting up a sole proprietorship, you might want to investigate liability insurance.