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Choose a legal structure for your online business
In many ways, formation of a commercial Internet venture is similar
to the formation of any other kind of business, and requires
that the founders consider conventional brick-and-mortar world
issues. However, given the rapid, uncertain, and ultimately "borderless"
development of global ecommerce law and taxation, online factors
argue for the adoption of certain business structures over others.
Types of legal structures
There are four basic legal structures related to the creation
of a business entity:
- Sole proprietorship is a business structure in which
an individual and his or her company are considered a single
entity for tax and liability purposes. In other words, the owner
files only a personal tax return and is personally liable for
all obligations of the business.
- Partnership is a type of business structure comprised
of two or more owners who are personally, jointly and severally
liable for all partnership obligations. A "Limited Partnership"
is comprised of General partners and Limited partners. General
partners are personally, jointly and severally liable for all
partnership obligations. Limited partners invest in the partnership
but have no management responsibilities and are liable for partnership
debts only up to the amount they have invested. Like a Sole
Proprietorship, a partnership is taxed as a "pass through"
entity – income is taxed at the shareholder level only.
- Limited liability company (LLC) is a type
of business structure in which the owners, called "members,"
enjoy limited liability from obligations of the business, up
to the amount they have invested. The LLC provides many of the
benefits of a corporation without some of the strict operational
- Corporation, the most common business structure,
has many legal rights and is viewed as an entity separate from
its owners. This separation limits owner liability for obligations
of the business. Corporations also provide for the transfer
of shares of stock and survive the death of their owners. All
corporate income is taxed at the corporate level and again at
the shareholder level when distributed as dividends.
Note: S-Corps. Corporate income is determined
at entity level passed through and taxed at shareholder level
regardless of whether distributed. Some S corporations pay tax
on built-in gains and excess net passive income however accumulated
earnings tax is not an issue.
Sole Proprietorships and Partnerships
In the brick-and-mortar world, many people initially decide to
form either a sole proprietorship or, if there are multiple owners,
a partnership. Both business structures are relatively simple
and inexpensive to establish and maintain. Conventional wisdom
holds that either structure is appropriate for owners who can
determine with relative precision the applicable tax laws and
rates and who can predict and minimize their risks of litigation
(one characteristic of both structures is that owners are personally
liable for all company debts, including judgment debts).
However, conventional wisdom doesn't always prevail on the Internet.
The principal reasons to avoid a sole proprietorship or partnership
in an online business are that fundamental concepts of jurisdiction
and taxation are changing too rapidly. An Internet entrepreneur
engaged in global or international ecommerce should not assume
that he or she can safely predict where in the world a Web site
would be determined to transact business and, consequently, where
liability for breach of contract, fraud, or taxes might arise.
It is therefore prudent for a new online business to organize
either as an LLC or a corporation, and for existing businesses
that are moving online to seriously consider reorganizing as LLCs
LLCs and Corporations
Forming an LLC or corporation is somewhat more complicated and
costly than creating a sole proprietorship or partnership, but
it is worth it. As long as the entity adheres to basic rules of
organization governance (easily accomplished with assistance from
an attorney or accountant), the owners' personal liability for
business debts and court judgments is limited. This limitation
can be critically important for Internet entrepreneurs. On or
off the Internet, tax considerations are another factor, because
no one can predict tax rates will apply.
At least from an Internet perspective, entrepreneurs and businesses
with multiple owners probably are better off forming an LLC rather
than forming a corporation. The LLC allows different classes of
ownership, whereas certain forms of corporation do not. This can
be ideal for an Internet entrepreneur who projects different levels
and stages of investor financing, because in such a situation
stock transactions can have different and more onerous tax consequences
(e.g. transfer of stock by an S-Corp. to anyone other than a natural
person destroys “S” status). Also, an LLC can offer
more flexibility than a corporation for allocation of profits
and losses and delegation of management duties. On the other hand,
a corporation may be able to offer certain forms of stock options
for key employees that an LLC can't.
Regardless of the individual nuances of your Internet venture,
forming an LLC or corporation for your small business online is
a routine matter for a lawyer or accountant with relevant experience.
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