3 Reasons to Form a Legal Entity - Structuring Your E-Biz the Smart Way

Like many other online retailers, you may not feel inclined to structure your online business as a legal entity. Maybe you argue that your business is too small or that you only sell on eBay. Or perhaps you feel the process is too expensive. But the real question isn't the size of your business, or how much it's worth. The real question is, how much can you afford to lose?

Personal Asset Protection
When you're operating as a sole proprietor, the law views you and your business as inextricably linked. Explains attorney Patrick O'Neill, "One of the biggest benefits of incorporating or forming an LLC is that your business becomes, in a legal sense, a completely separate entity from you and any other shareholders." So in the unfortunate event that your business is sued, a judgment against your business doesn't extend to your assets, other than those invested in the business. Similarly, your business' creditors can only come after company assets - your house, life savings, and stamp collection remain safely out of reach.

Image Enhancement
Besides putting a virtual firewall around your personal property, you're also strengthening your business' image. This is especially important, because as a small home based business owner, you're already at a disadvantage:

. First, as a small, unknown business, you have to work hard to create credibility with your customers. Unlike a well-known chain store, you must convince shoppers that you can consistently provide top-quality products and first-rate customer service.

. Second, when you sell online, you lack a physical storefront where shoppers can walk around and get a sense of the kind of operation you run, and whether they feel comfortable purchasing from you.

Seeing XYZ Business, Inc. goes a lot further towards reassuring potential buyers that you've been verified, than a generic XYZ Business. The same is true for other organizations with which you do business. Wholesale suppliers and loan officers, for example, are more likely to take you seriously. Even the IRS is less apt to audit a home business that's an established formal entity - they believe the odds are much higher that the owner isn't just looking for illegitimate tax deductions.

Tax Flexibility
LLCs and S-corporations were both developed with small businesses in mind, and both eliminate the double taxation of a traditional corporation. A C-corp is taxed on its earning as if it were an actual person. Post-tax profits pass through to shareholders, who must include them in their reported taxable income. For Coca-cola, this might be bearable; but for a small eBay business, double taxation can be a crushing burden. An LLC or an S-corp, on the other hand, allow you to be taxed as a partnership, so you're not paying taxes at entity-level. You're only required to fill out an information return for your business, and the profits and deductions pass through proportionally to the shareholders.

. An LLC is much easier to form than a corporation, and the compliance formalities are less stringent. The operating agreement can be as flexible as you choose to make it.

. An S-corp is basically a small business corporation, or a corporation that's taxed as a partnership. It is generally less adaptable than an LLC in income distribution and imposes greater ownership restrictions.

For the entrepreneur, forming a legal entity presents a tremendous value proposition. "You're taking preventative measures in protecting yourself and proactive measures in creating greater credibility," advises O'Neill. "So you're helping yourself on the front and back ends."