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Module 3: Setting Up Your Business
Manual 2: US Citizens
Contents:
The
(
S ole
As
(
(
S mall
Overview
In this manual, we’ll go into a little more detail about US business entity types (including information about
tax treatment) and give you some guidance on how to go about getting a business entity set up. We’ll
also provide some direction on how to get a seller’s permit. (We’ll also talk about how to proceed if you
decide not to set up a business entity.)
Before we begin, we want to make sure you’re aware that we are NOT attorneys or CPAs. We’ve tried to
put together a good overview of the different entity types and how they are taxed and what advantages
and disadvantages they have. But this is just a summary. We strongly encourage you to consult with an
attorney and/or CPA to gain a full understanding of these concepts and to understand what your tax and
reporting requirements will be.
- Entity
Doing
Limited
(
Sales
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The No-Entity Option (Sole Proprietor)
As we’ve mentioned a few times now, you are NOT required to set up a business entity in order to build
and operate your e-commerce store. Don’t let the dread of governmental “red tape” stop you from this
great opportunity! Keep in mind that you can always start off without creating a business entity and then
add one later once you’re up and rolling.
If you don’t set up a business entity, you will automatically be what is called a Sole Proprietor . It is the
simplest form of business ownership. As a sole proprietor, there is really no separation between you and
your business... they are one and the same. You report your business’ revenue and expenses on your
own personal tax return (1040) using ‘Schedule C” (which is PART OF the 1040 package), which is great!
It means you don’t have to file a separate tax return for your business.
The biggest drawback to the sole proprietor option is that you are personally liable for business-related
obligations (such as company debts, losses, or legal claims). But honestly, unless you’re planning to sell
a high-risk, potentially harmful product, legal liability is probably not a huge concern.
In most states, you’re not required to file anything with the state in order to start operating a business as a
sole proprietor. But keep in mind that most cities and many counties require ALL businesses (even home-
based sole proprietorships) to register with them and get a business license, a seller’s permit (which you
really want), and possibly a zoning permit. (In practice, lots of businesses are small enough to get away
with ignoring these requirements, but you could be subject to back taxes and/or penalties if it’s caught.)
Here are links to a couple of pages where you can learn more about being a sole proprietor:
● http
://
. g ov
/ r egister
/ s ole
● http
://
. n olo
. c om
/ legal
/ a rticle
- 29694.
Doing Business As (DBA), Assumed Business Name (ABN), or Fictitious Business Name.
First off, we want to clarify that these three terms all mean the same thing and are used interchangeably,
so don’t be confused about that! From here on out, we’ll always refer to them as DBAs.
DBAs give you the best of both worlds! They allow you to do business using an official-sounding business
name (instead of your own personal name) without having to create an official business entity. With a
DBA, you can operate as Omni Solutions rather than John Smith (even though it’s really you, John
Smith). You can also get a seller’s permit in the DBA’s name, which is very important for getting accounts
with suppliers.
You are required to register your DBA, but the process is incredibly easy and usually pretty cheap ($10 to
$50). In a few states you register your DBA with the Secretary of State, but in most states (including
California) you’ll register it at the county level. Click
here
to
access
state
- s tate
for
how
. (If this link doesn’t give you what you need, just call your county clerk’s office to find
out its procedures, requirements, and fees.)
DBA
Here are a couple of links to sites with more good information about DBAs:
● http
://
. n olo
. c om
/ legal
/ a rticle
- 30262.
● http
://
. com
register
your
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Limited Liability Company (LLC)
The LLC is probably the easiest and simplest option for those who want an actual business entity. LLCs
are easy to set up, they provide a personal shield against legal liabilities of the business, and they are
very easy from a tax treatment standpoint. They basically combine the best features of sole
proprietorships and corporations.
Generally, LLCs are taxed as partnerships and report their income and expenses on a separate tax form
called the 1065. However, there is a wonderful exception (which applies in most cases): as long as you
are the sole
LLC owners are protected from personal liability for business debts and claims. So if the business owes
money or faces a lawsuit, only the assets of the business are at risk. Creditors usually can’t reach your
personal assets, such as your house or car. (Regardless of what type of entity you form, you can lose this
protection by acting illegally, unethically, or irresponsibly.)
See the ‘ Registering a Business Entity ’ section below for more information about how to create an LLC
(or any other type of business entity).
Here are links to a couple of pages where you can learn more about LLCs:
● http
. g ov
/ r egister
/ l lc
● http
. n olo
. c om
/ legal
/ a rticle
- 30163.
Partnership
Partnerships are quite similar to LLCs and have been around for a lot longer. In fact, LLCs were created
as kind of a hybrid between partnerships and corporations, offering the best features of both. Honestly,
we don’t see any reason to go with a partnership rather than an LLC, but it’s something you may want to
discuss with your attorney and/or accountant.
We will take the opportunity here to talk about tax treatment of both a partnership and an LLC when you
own the business with another person (who is not your spouse). As we said above, LLCs are generally
taxed as partnerships (unless you specifically elect to be taxed as a corporation) so the tax treatment for
LLCs (with multiple, non-spouse owners) and partnerships (with multiple partners) is the same.
Multi-owner LLCs and partnerships are required to file a Form 1065. This is really just an “informational
tax return” because the LLC (or partnership) is NOT a taxable entity; it is a “pass-through” entity. In other
words, it does NOT pay taxes. The Form 1065 simply shows the income and expenses of the business,
and then it shows what portion of the net income belongs to each owner/partner. For example, if the LLC
(or partnership) had $100,000 of net income and was owned 50/50 by two people, then each owner’s
share of the net income would be $50,000. That $50,000 would be reported on a form called a K-1, which
would be given to each owner/partner. Each owner/partner would then report the earnings shown on the
K-1 on their personal tax returns (1040).
of the business (it’s okay if your spouse co-owns it with you, as long as you file a joint
tax return), you can just report the business’ activities on ‘Schedule C’ of your personal tax return (1040),
just like a sole proprietor. So LLCs are basically taxed the same way sole proprietors are taxed!
owner
://
://
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Here are links to a couple of pages where you can learn more about LLCs:
● http
. g ov
/ r egister
● http
. n olo
. c om
/ legal
/ a rticle
- 30072.
S Corp (Small Business Corporation)
We don’t want to get too technical here, but there is a place for S Corps in certain situations. Really, S
Corps are very similar to LLCs... but there are two major differences (the first is negative, the second is
positive):
1. S Corps always have to file a separate business tax return (Form 1120-S), even if you
are the sole owner of the S Corp. (See below for more info about tax treatment of S
Corps.)
2. Using an S Corp can help you save some money on self-employment tax (also known as
SE tax, payroll taxes, FICA taxes, or Social Security / Medicare).
Just like LLCs and partnerships, an S Corp is a “pass-through” entity where the income of the business is
“passed through” to the owners of the company (through the K-1s), and each individual owner reports
his/her share of the business’ net income on his/her personal tax return (1040). So here again, the S Corp
does NOT pay any taxes; it is only required to file an informational return (Form 1120-S) which basically
just tells the IRS what income it can expect to see reported on each owner’s personal tax return.
Regarding point 2 above, S Corps can be useful to help reduce self-employment tax in cases where your
business starts to make a lot of money. With all the other entity types we’ve discussed above (sole
proprietors, LLCs, and partnerships), 100% of the business’ net income (revenue minus expenses) is
subject to self-employment tax. But with an S Corp, you can pay yourself a salary (which can be LESS
than the net income, as long as it’s reasonable) and only that salary amount is subject to self-employment
tax. Then you can take the remaining amount as a “distribution” (not as salary), which is not subject to
self-employment tax. Of course, to be able to do all of this you have to set up payroll services, which can
be an administrative burden.
Like with all issues pertaining to entity selection and tax compliance, we strongly recommend that you
advise an attorney and/or tax accountant before you proceed.
Here are links to a couple of pages where you can learn more about S Corps:
● http
. g ov
/ r egister
● http
. n olo
. c om
/ legal
/ a rticle
- 30002.
://
://
://
://
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Corporation
Corporations (sometimes called ‘C Corporations’ to distinguish them from S Corporations) have a place in
big corporate America, but they don’t make sense for what you’re doing here. Most of the advantages of a
C Corp have to do with issuing stock, paying dividends, “going public”, transferring ownership, and those
kinds of things (which probably don’t matter to you). But C Corps have a MAJOR downside: double
taxation! All the earnings of the C Corp are taxed at the corporate level (the C Corp actually pays taxes
itself). Then, whatever is left over after paying Uncle Sam is distributed to the shareholders (owners) of
the company... and they each have to pay taxes again! So unless you really want to pay taxes twice, we
would advise against creating a C Corp.
Here are links to a couple of pages where you can learn more about C Corporations:
● http
. g ov
/ r egister
● http
. n olo
. c om
/ legal
/ a rticle
- 29867.
Our Recommendations
option OR
the LLC option. From a tax standpoint, these two options are exactly the same. You won’t have to file a
separate business tax return; you can just report the business’ income and expenses on your personal
1040. Being a sole proprietor is easier and cheaper to get started than creating an LLC; the only real-
downside is that you don’t get that “corporate shield” of legal liability protection. If you do decide to be a
sole proprietor, we strongly recommend that you pay the small fee to get a DBA so your business looks
more professional to suppliers and so that you can obtain a seller’s permit.
Proprietor
If you co-own the business with one or more other person(s) other than your spouse. In this case,
we would recommend creating an LLC. You will have to file a Form 1065 (which is an administrative
hassle), but the business itself doesn’t get hit with taxes; the business’ income simply “passes through” to
you as an owner. And you get the protection against legal liabilities of the business.
If your business makes a lot of money. As explained above, S Corps can save you a fair amount of
money on self-employment tax in situations where your “bottom line” is substantial. But they do present
the administrative hassles of processing payroll (and all the payroll tax requirements that come with it)
and of filing a Form 1120-S every year. You may want to keep the S Corp option in mind for a future date,
but if you’re just starting out you probably want to keep it simple and go with a Sole Proprietor or LLC for
now. You can always “upgrade” to an S Corp later on.
And our #1 recommendation. Remember that we are not CPAs and that this document is only a
summary. We strongly urge you to consult an attorney and/or CPA to gain a full understanding of these
concepts and to understand what your tax and reporting requirements will be.
://
://
If you are the sole owner of the business OR if you co-own the business with your spouse (with
whom you file a joint tax return). We would recommend going with either the Sole
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