You may not have considered it, but if you're starting an Internet business, you're starting an actual business. That means constructing a legal entity, usually a sole proprietorship, an LLC, or a corporation. By default, you have a sole proprietorship, but this formation offers you little in the way of protection or tax benefits. So what are your other options?
Limited Liability Companies (LLCs)
- The Upside: Your personal assets aren't exposed in a lawsuit relating to your business. This is especially important if you sell products that are costly, or inherently risky, like heavy machinery or used manufacturing equipment. With an LLC, an unhappy customer can only sue your business; they can't come after your personal assets, such as your home, cars, or personal bank accounts.
- The Downside: You, as an owner, are legally unable to draw a salary. You may, instead, take a percentage of the company's profits. This usually means that, after the business expenses are paid each month, you and any partners equally divide the remaining profits. But you need to remember that, because you don't deduct taxes from a regular paycheck, you have to pay estimated taxes once a quarter. So you need to be escrowing between 30-40% of your gross income — otherwise, when your taxes are due, you'll to be in serious trouble.
How Do I Get Started?
"There are some excellent services online right now that can help you get set up," says Ennico. LegalZoom.com and MyCorporation.com both have solid reputations. However, be very careful because there are also many sites that will only take you through two or three of the five or six steps that are required for you to become fully incorporated. You don't want to find yourself being audited because your "service providers" didn't tell you that you have to register for sales tax in your state, or some other significant "detail".
An attorney is a more costly alternative, but they will take you through every step of the process. If they miss anything, they're liable for malpractice and can lose their licenses, so they're very motivated to make sure you're set up correctly. When forming an LLC or corporation, you should never pay an attorney by the hour. Any lawyer who's been practicing for any length of time knows exactly how long this process will take them, and should be charging you a flat rate that includes all out-of-pocket costs and filing fees.
People are often surprised and somewhat nervous to realize there are legal implications to establishing a business, but it's not all that complicated. It's just a matter of choosing the business structure that provides the best tax advantages and legal protection, and then getting set up accordingly.
- The Upside: A corporation may work best for you if you have more than a few employees and are contemplating setting up a benefits program for them. According to attorney Cliff Ennico (CliffEnnico.com), "You may get a bigger bang for your tax dollar by setting it up as a corporation because you can do a lot more creative things with benefit programs. LLCs are limited in how they can deduct things."
- The Downside: Forming a corporation is significantly more costly. It can cost double or more than forming an LLC.