Sole proprietorship vs LLC. Which is better? As you embark on your journey into the world of Amazon FBA, it’s important to understand the different business structures available to you.
Let’s explore the two most common options: Sole Proprietorship vs LLC (Limited Liability Company).
But don’t worry, we won’t drown you in confusing jargon. Instead, we’ll provide clear information to help you make the right choice.
What is a Sole Proprietor?
Imagine you want to start selling products on Amazon. Instead of going through all the complicated legal stuff to set up a separate company, you can just be a sole proprietor.
Sole proprietorship is the default business type whenever you start something as a single person. This makes it a popular option among solopreneurs in the United States.
Sole proprietors operate as “individuals.” This means a store and its owner are recognized as the same entity. Plus, there’s no need to register the store, nor to establish an income source.
That lemonade stand at the corner of your street is an example of a sole proprietor business, but so is your friend who works as a freelancer on platforms like Toptal or Fiverr.
What Does Sole Proprietor Mean?
There are 3 types of sole proprietorship:
- Independent contractor. This category is reserved to self-employed individuals who take on contracts with specific clients. Freelancers would qualify as independent contractors, for instance.
- Franchisee. You’ll manage a small store for a larger business entity. The franchise is already set up, and you get to manage it like a pro while collecting royalties. It’s like running the show without having to start from scratch.
- Business owner. This is for those entrepreneurs that offer specific products or services, and need both employees and a business plan with a strong structure to support sales. In other words, it’s a full-fledged business entity.
Related content: Amazon Vendor vs Seller
How to Register as Sole Proprietor
- Choose a Business Name. Make it catchy, but make sure it’s not already taken. The last thing you want is trademark trouble. Consult the United States Patent and Trademark Office (USPTO) to check if your selection is available.
- Register Your Business Name. You can use your own name or opt for a “Doing Business As” (DBA) name. The latter option is very useful when setting up your store’s bank account, since banks must separate your personal funds from your business assets.
- Get a Business License. Most US cities require a business license from entrepreneurs. Check with your local government for any permits you might need. Avoid hefty fines, folks!
- Request an EIN: An Employee Identification Number is only necessary for the bosses planning to run a full-fledged business. It’s a must for IRS tax filing and retirement plans. Go to the Small Business Administration site to get your EIN in no time.
- Set Up a Bank Account: Keeping business funds separate is smart, and helps you accept those credit card payments like a pro. This will also help you build a solid credit history.
- Get Insured: Stay protected from business liabilities with proper insurance. Consider filing for property, auto health, disability and liability insurances. The initial cost may be steep, but you’ll safeguard your venture against any unforeseen bumps.
Sole Proprietor Taxes
Taxes are always a hard topic to approach, but for sole proprietors, the specifics are pretty straightforward. Let’s check some of these points:
- You can roll up business and personal assets into a single category, to prevent double taxation.
- Your profits are treated as “pass-through”. So, they are treated as regular income.
- You’ll pay both income tax and self-employment tax (FICA) as the sole trader on your Amazon earnings.
- The federal tax rate varies from 10% to 37%, depending on your yearly Amazon sales.
- FICA tax rate is 15.3% if your annual net sales are up to $142,800.
Sole proprietorship tax filing will depend on the type of business you run. Go to the IRS business page to learn more about how to file taxes as a sole proprietor.
Sole Proprietors Aren’t Fully Safe on Amazon
So, as you have probably guessed by the data above, a sole proprietorship has some notable perks. It’s quick to start, you don’t need fancy paperwork, and handling taxes on your own is not that hard. However, this doesn’t mean that there are no downsides.
People sell different types of products on Amazon – from home essentials to automobile supplies to everything in between. Some of these products carry safety or health risks.
If your customer gets harmed using your product, they can potentially sue your business. And since you and your business are one and the same, the liability would automatically transfer to you. You can lose your home, car, and other personal assets along with the business that you’ve worked so hard to build all these years.
As a matter of fact, there are attorneys in the US who specialize in this very area of consumer protection law. They work round the clock to find unprotected business owners and their unhappy customers to bag a potential client.
Sole proprietorship is okay if you want to test the market or flip a few retail items for quick wins. But remember that, in this model, your business and you are like a duo – inseparable. So, if something goes south in your business and you face legal issues or lawsuits, your personal assets are at risk too.
So, for those who dream big and want to build a brand and replace that full-time income, being a sole proprietor might not be the best way to sell on Amazon.
What is an LLC and Why Should You Consider It?
An LLC, or Limited Liability Company, is a business structure that combines elements of both corporations and partnerships. Thus, an LLC provides personal liability protection to its owners.
Under this specific condition, the business and its owners are considered separate legal entities, which makes it easier to protect personal assets from business troubles. This makes Limited Liability Companies the best approach to sell on Amazon.
LLCs can also help you reduce your tax bills by applying for different deductions and saving money that you can then reinvest into your Amazon store.
Of course, an LLC isn’t perfect in every way and has some drawbacks too. In fact, we recommend consulting your case with a local CPA for tailored advice.
Benefits of LLC vs Sole Proprietorship
There are some tax benefits that you only get to enjoy if you are an LLC owner. For example, you can write off your Amazon VA salary as a business expense when filing your taxes – if the amount paid is below a certain threshold.
The most significant tax gains, however, come if you tax your LLC as an S-corp. This is where you can actually save on self-employment tax by accepting income in part salary and part distributions.
According to US laws, S-corp distributions aren’t subjected to self-employment tax. Plus, the federal income tax rate for both LLCs and sole proprietors is the same, with the lowest tax rate set at 10%.
Setting up your LLC
- Choose a State. LLCs are registered with the state and not the federal government.
- Pick a Name. Find a unique and available name for your LLC. Just make sure it follows your state’s naming rules, which might require including “LLC” in the name.
- Get a Registered Agent. Your LLC needs someone to handle official documents, and that’s your registered agent. They should have an address within the state where your LLC is based.
- File Articles of Organization. This is an essential document that officially forms your LLC. It includes vital details like your company’s name, address, and purpose.
- Make an Operating Agreement. Though not always mandatory, it’s a good idea to have an operating agreement. It outlines how your LLC will run, its management, and other important procedures.
- Get an EIN. Think of it as a Social Security number for your LLC. It’s needed for taxes and opening a business bank account.
- Open a Business Bank Account. To keep personal and business finances separate, open a business bank account. It helps with keeping records and makes it clear which expenses are personal and which are business-related.
- Check Permits and Licenses. Depending on your business type and location, you might need specific permits or licenses to operate legally. Check with your local and state authorities to know what you need.
- Stay Compliant and File Taxes. After setting up your LLC, be aware of any ongoing requirements like filing annual reports or paying state fees. And make sure to handle your business taxes properly, based on the chosen tax treatment for your LLC.
- Cost and Duration. Setting up an LLC is budget-friendly, starting from as low as $45 in some states. And don’t worry; it won’t take ages – around a week, give or take.
LLC vs Sole Proprietorship
LLCs offer personal liability protection, which is a significant advantage. As an LLC, your personal assets are generally protected from business debts and legal claims.
Another benefit of an LLC is its flexible tax options. By default, an LLC is classified as a pass-through entity for tax purposes. This means that the business itself does not pay federal income taxes.
Instead, the profits and losses “pass through” to the individual members, who report them on their personal tax returns. This simplifies the tax-filing process and reduces administrative burdens for small business owners.
When comparing sole proprietorship vs LLC, the sole proprietor model is simpler and easier to set up. There is no need to file formal paperwork, making it an attractive option for those looking to test a business idea or operate on a smaller scale.
However, a sole proprietorship comes with a significant downside – personal liability. In this business structure, there is no legal distinction between the business and the owner. As a result, the owner is personally responsible for all business debts and legal obligations.
If the sole proprietorship faces financial difficulties or lawsuits, the owner’s personal assets are at risk, which can be a considerable concern for those seeking asset protection.
Changing Between Sole Proprietorship vs LLC on Amazon
What if someone has already started selling on Amazon as a sole proprietor and wants to change to LLC? Is it possible to do that?
Absolutely! If you’re already a sole proprietor selling on Amazon and want to switch to an LLC, it’s doable. Just update your Amazon account business details in the settings menu.
Simply click on Legal Entity and update the information. Also, make sure the changes are saved, or Amazon can shut down your account.
Please note that, if you are a single-member LLC, you don’t need to change your tax information. Instead, Amazon will tax you on your SSN. For more information, consult your CPA.
Choose Based on a Strong Business Plan
Planning your business structure for Amazon is a crucial step to getting started on your selling journey.
The choice between sole proprietorship vs LLC should be based on your individual circumstances, risk tolerance, business objectives, and tax considerations.
When it comes to selling on Amazon, we recommend going for LLC. It offers liability protection and has better tax advantages.
You don’t get this protection if you sign up as a sole proprietor on Amazon. But if simplicity and ease of setup are more crucial to you, a sole proprietorship could be the preferred route.
To make the most informed choice, consult with a business or legal advisor who can guide you through the specifics of each model. You’ll also learn about the key differences between sole proprietorship vs LLC, and determine which aligns best with your goals.
A marketer writer at heart, and Amazon evangelist around-the-clock. Hammad can often be found discussing the ins and outs of the marketplace across the web. In the very rare instances when he is not busy educating the audiences, he likes to sit down and have a good me-time watching the latest football action on his large-sized TV screen.
Esteban Muñoz is a content writer at AMZ Advisers, with several years’ experience in digital marketing and e-commerce. Esteban and the AMZ Advisers team have been able to achieve incredible growth on Amazon for their clients by optimizing and managing their accounts, and creating in-depth content marketing strategies.