Most sellers who start an Amazon FBA account choose sole proprietorship as their business entity due to sizable profit margins and ease of management. But as you attempt to scale up your company, you’ll find it difficult to move forward as your capability to raise capital is quite limited. This begs the question, “what is the best Amazon business entity?”
Choosing the correct structure for your business is crucial as it’ll affect three key factors: record keeping, taxation, and liability. Here’s an in-depth guide on the different legal structures to help you pick one that suits your needs.
What should you consider when choosing an Amazon business entity?
As a new seller on Amazon, it can feel confusing to establish the legal structure of your business, especially if it’s your first time doing it. Some people skip this part and go straight to selling products through FBA. But as with most businesses, there are inherent risks when running an online store, like customer disputes, intellectual property infringement, and more.
A legal entity is an absolute must to safeguard your assets and protect your business from regulatory penalties. Getting it right the first time can help save you time, money, and resources, allowing you to scale your FBA business and maximize it to its full potential.
With those said, here are some considerations before you choose the legal structure of your Amazon FBA business:
One of the first things you must consider when choosing a business identity is tax obligations. Choosing the correct structure can not only lower your tax bill but also allow you to generate more profit.
For example, an entity that shoulders the company tax through the owner’s income tax can cut your tax burden in half. This is because the corporate rate is almost twice the personal income rate, so keep that in mind when building the legal structure of your business.
2. Asset protection
Selling online exposes you to risks that can lead to legal complaints. If your products prove faulty, the customer can take action through civil court and cause financial repercussions to your business.
To protect your personal assets, you want to choose a business entity with a separate legal personality to minimize your liabilities as a business owner.
Different entities have different levels of involvement as an owner. It’s up to you to decide whether you want full control of the business or let others handle the daily responsibilities of business management.
If you’re comfortable operating the business by yourself, then a sole proprietorship is a good choice. On the other hand, a limited liability company (LLC) offers flexible management for those who want to get less involved with the business.
How do I choose the correct Amazon business entity?
Determining the legal structure of your company requires careful planning and consideration. Here are the different business entities that you should learn more about:
1. Sole proprietorship/sole trader
A sole proprietorship is the most common business entity for Amazon sellers as it’s easy to establish and doesn’t require massive funding upfront. The great thing about a sole proprietorship is you benefit from pass-through taxation, meaning you are not required to pay taxes on the entity level.
Business owners who wish to oversee the entire operations will find a sole proprietorship the ideal legal structure for their company. It’s a simple way of doing business, and with that comes the downside of having unlimited liability the business incurs.
You can combat liability risks through insurance and well-written contracts. With minimal paperwork and low set-up costs, a sole proprietorship is ideal for first-time Amazon business owners.
2. General partnership
A step above sole proprietorship is a general partnership, where two or more people engage in business and share profits, assets, and financial/legal duties. Think of it as two or more sole traders merging to form a business partnership. The agreement consists of ownership percentages, management rights, profit/loss sharing, and more.
For example, say you sell products on Amazon under the electronics category, and your partner sells products in the computers category. You and your partner can enter a general partnership and form a joint business where you can expand your product portfolio and earn more profits.
Like a sole proprietorship, a general partnership holds owners jointly liable for any liabilities the business incurs. In terms of taxation, a general partnership is a tax-reporting entity, meaning the owners must file an annual information return to the IRS. You benefit from pass-through taxation like a sole proprietorship, which leads to fewer tax obligations.
3. Corporations (C-corp and S-corp)
Corporations are the most complex of all legal structures due to their independent entity from the business owners (i.e. shareholders). The shareholders elect a board of directors to oversee business operations. Larger companies prefer corporations due to limited personal liability, business security, and easier access to capital.
There are two types of corporations; C-corp and S-corp. Let’s tackle the two in greater detail.
- C-corporation – A C-corporation is a type of legal structure that is recognized as a separate taxable entity. The company pays tax on its earnings, and the shareholders pay tax on dividends, which leads to double taxation. The major benefits of a C-corporation are the unlimited number of shareholders and zero ownership restrictions. Anyone can own shares and issue more than one class of stock, whether they’re U.S. citizens or not.
- S-corporation – A S-corporation follows a similar structure to a C-corp through ownership of shareholders. It’s a pass-through legal entity that files an informational federal return but does not pay income taxes at the corporate level. The advantages of an S-corporation include a single layer of taxation, pass-through of losses through its shareholders, and up to 20% business income deduction thanks to The Tax Cuts and Jobs Act of 2017.
A C-corporation makes sense if you want to venture business capital in the future or acquire investment funding. The flexibility of ownership and the multiple classes of shares make it appealing to investors.
An S-corporation is an ideal choice if you’re a small business with high earnings. The single layer of taxation helps ease tax burdens and the owners can pay themselves a salary subject to taxes. Keep in mind that an S-corporation is limited to 100 shareholders only, and all of them must be U.S. citizens.
4. Limited liability company (LLC)
A limited liability company is a combination of a sole proprietorship, general partnership, and corporation. It’s the most preferred choice for Amazon sellers because of flexible taxation and personal liability protection. Owners of LLC companies are called “members” and can be formed with one or more members.
Like a sole proprietorship, an LLC company enjoys tax benefits since the business income is taxed as your personal income. Your personal assets are also protected as an LLC provides owners with limited liability. In case a customer sues your Amazon business, only the business assets are at risk and not your personal assets.
For Amazon sellers who want the tax benefits of a sole trader/general partnership but don’t want to deal with the complexity of a corporation, limited liability is an ideal entity for your business.
When it comes to legal structures, there is no one-size-fits-all solution. Amazon sellers will need to determine which entity best suits their situation to ensure they can scale their business going forward. Hopefully, the information in this article can help you make an informed decision on the type of entity you will choose for your Amazon business.
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