The best business structure for online business ventures, such as ecommerce businesses, is one that optimizes tax savings, provides liability protection, and supports future growth. The business structure that you choose affects everything from your personal liability to your tax obligations.
Limited liability companies (LLCs) and S corporations (S corps) are two popular business structures for ecommerce businesses. Each offers distinct advantages, but which one is best suited to your ecommerce goals?
Overview of LLC vs S Corp Business Structures
Understanding the benefits and drawbacks of each business entity is key when choosing between an LLC and an S corporation for your ecommerce business. Consulting a CPA firm specializing in business structure consulting will ultimately help you ensure that you set up your specific business to maximize tax benefits and liability protection.
Limited Liability Company (LLC)
A limited liability company combines the flexibility of a partnership or sole proprietorship with the legal protection of a corporate structure. Single-member LLCs are a flexible option for solo entrepreneurs, while multi-member LLCs offer shared ownership, allowing multiple owners to benefit from limited liability protection and a flexible management structure.
The LLC legal structure is appealing to small ecommerce businesses due to its simple setup and limited compliance requirements. Startups often choose LLCs to allow business owners to focus on growth without complex regulations.
S Corporation (S Corp)
An S corporation is a special tax designation under Subchapter S of the Internal Revenue Code rather than an actual business structure. It combines elements of both LLCs and corporations by allowing income and losses to pass through directly to shareholders’ personal tax returns, avoiding double taxation on shareholders. However, S corps must follow stricter corporate rules than LLCs, such as maintaining a formal board and holding regular meetings.
To qualify for S corporation status, a business must be domestically incorporated with no more than 100 shareholders, who must be U.S. residents, specific types of trusts, or estates. Partnerships, corporations, and non-resident aliens cannot be S corp shareholders, which limits the flexibility of ownership compared to an LLC.
Safeguarding Personal Assets
Both LLCs and S corps create a separate legal entity, shielding personal assets from business liabilities. This ensures that in the case of business debts or legal disputes, personal assets such as your home or savings are protected.
Managing Your Ecommerce Business’s Tax Liability
Taxation is a key factor when determining the best business structure for your ecommerce company. Both LLCs and S corps provide pass-through taxation benefits, but they differ in how owners report and pay personal taxes.
Corporations Pay Income Tax
It’s important to note that C corporations, unlike LLCs and S corporations, are subject to corporate income tax. This means the business pays taxes on its profits at the corporate level, and shareholders also pay taxes on dividends received, resulting in double taxation. In contrast, both LLCs and S corporations avoid this by passing business income directly to the owners, who then report it on their personal tax returns.
LLC Taxation
LLCs offer flexibility in taxation because they can opt to be taxed as a sole proprietorship, partnership, S corporation, or C corporation. By default, a single-member LLC is taxed as a sole proprietor, meaning business income is reported on the owner’s personal income tax return. Multi-member LLCs are taxed as partnerships, which maintain pass-through taxation benefits to avoid double taxation on members.
However, LLC owners are required to pay self-employment taxes on the personal income they receive from the business, which may increase their overall tax liability. This setup works well for moderate-revenue ecommerce businesses, but the self-employment tax may impact profits.
S Corporation Taxation
S corps offer tax savings by allowing owners to divide their income between a reasonable salary and distributions. The salary portion is subject to payroll taxes, while distributions are not, potentially saving money on taxes for an ecommerce business with higher profits.
Electing S Corporation Tax Status for an LLC
An LLC can choose to be taxed as an S corporation by submitting IRS Form 2553. This allows LLC owners to continue enjoying pass-through taxation benefits while splitting their income between a salary and distributions. Since only the salary portion is subject to payroll taxes, there’s potential for tax savings for businesses generating significant revenue.
Note: Despite the change in tax status, the LLC retains its legal structure and operational flexibility, making it an attractive option for businesses looking to minimize tax liability while keeping flexible management.
LLC Flexibility in Profit Allocation
One key advantage of the LLC structure is its flexibility in allocating profits and losses among owners. Unlike S corporations, which must distribute profits and losses strictly based on ownership percentages, LLCs can allocate them disproportionately. This flexibility can be especially beneficial if multiple LLC owners have different roles or levels of involvement in the business, allowing financial interests to be tailored to individual contributions.
Administrative Requirements
LLCs and S corps have different levels of administrative complexity and compliance requirements.
LLC Flexibility
An LLC structure is simpler to manage, with fewer formalities. Owners can choose between a member-managed or manager-managed structure, and there’s no requirement for a board of directors or regular meetings. This makes LLCs ideal for small ecommerce businesses that want to minimize administrative overhead.
S Corporation Requirements
S corps come with stricter administrative requirements. They must maintain a board of directors, hold regular meetings, and file more documents with the IRS. Although this may seem daunting at first, these formalities are manageable, especially for an ecommerce business planning to expand or bring on shareholders.
Continuity and Stability
S corps maintain a separate legal identity from their shareholders. If an S corp shareholder leaves or sells their shares, the business continues uninterrupted. This structure ensures stability and continuity, unlike LLCs, which may face dissolution if an owner exits unless specified otherwise in the operating agreement.
Specific Considerations for Ecommerce Businesses
When choosing between an LLC and S corp for your ecommerce business, consider how each legal structure aligns with your long-term goals.
Scalability and Growth
LLCs are ideal for startups due to their simplicity, but S corps may be better suited for ecommerce businesses with significant growth potential. S corps offer the ability to raise capital through shareholders and enjoy tax advantages on distributions, making them a good choice for businesses focused on scaling.
Investor Appeal
S corps typically have a stronger appeal for investors due to their more structured corporate framework and clearer governance. If your ecommerce business is seeking outside funding, the S corp structure might present a more organized and professional option.
Sales Tax Compliance
Sales tax compliance is crucial for ecommerce businesses operating in multiple states. Both LLCs and S corps must comply with state tax laws, but the additional administrative structure of an S corp may be better suited to handle multistate tax compliance as the business expands.
Choosing the Right Structure for Your Ecommerce Business
Deciding between an LLC and an S corp for your ecommerce business depends on your current size, tax considerations, required level of liability protection, and growth plans. LLCs offer simplicity and flexibility, making them ideal for small and medium-sized operations. S corps, on the other hand, provide tax savings and investor appeal, making them a better option for businesses focused on scaling.
Ultimately, the right business structure will depend on your unique goals and circumstances. Consulting a tax professional will help ensure your decision minimizes your tax burden and protects your assets while setting your ecommerce business up for long-term success.
