1. Sole Proprietorship vs LLC
2. Advantages of an LLC
3. Advantages of a Sole Proprietorship
4. Reasons for Incorporating in Another State
5. Disadvantages of Out-of-State Incorporation

Should I incorporate my online business? The answer to this question will vary based on your business type and personal situation. You must research your options and decide whether incorporation is right for you.

As you are starting your online retail business, you're focused on your website, marketing, products, shippers, customer service, finances and more. Deciding on your legal structure may be on the back burner, but it is something you should consider sooner rather than later. If you are a solo business owner, you can be a sole proprietorship or a limited liability company. If there is another person, like a manager or a spouse, you can opt for a partnership or LLC.

Sole Proprietorship vs LLC

The simplest business structure is a sole proprietorship, which does not need to be registered with the state. You can use your Social Security number for taxes rather than obtaining an Employer Identification Number (EIN) from the IRS. If you opt for an LLC, you need to register online with your Secretary of State's office and file Articles of Organization. There is an associated filing fee, and you need to create an operating agreement for your LLC.

Research your specific state's requirements on the Secretary of State's website. It doesn't matter which business type you opt for, just make sure you have the right business licenses needed in your state. No matter whether you are a sole proprietorship or LLC, the net effect of taxation is the same. You will report your federal income on IRS tax form 1040, Schedule C. You are only subject to taxation one time rather than with a corporation that is taxed at the corporate level and again on their individual returns.

Advantages of an LLC

  • Using an LLC with your name provides you with more credibility for your business.
  • Customers have more security shopping with a business registered with the state.
  • LLC means limited liability, which means your liability is limited if a lawsuit is filed against you.
  • Protects your business name so no one else can register with it in the same state.

Advantages of a Sole Proprietorship

With a sole proprietorship, if you close your business, there is no need to file a bunch of forms, nor are there procedures to follow, whereas an LLC manager has to register the closure with the state and distribute the company's assets per the terms of the operating agreement.

Reasons for Incorporating in Another State

Some people opt to incorporate in a state other than the one where they live. This can result in tax benefits in some cases, while states like Delaware are popular for their safer business laws, and Nevada for its privacy. There are online services that will help you incorporate in whatever state you want, you just need to make a decision as to which one.

Factors to look for when choosing where to register your LLC include:

  • Tax breaks — if you are located in a high-tax state like California, neighboring states may be a better option to save on the $800 franchise tax levied on all businesses, regardless of size or income.
  • Better business laws — Business owners love Delaware for its favorable business climate, with long-established business laws, renowned case law precedents, efficient court processing times, and the Court of Chancery, which only hears corporate cases.
  • Privacy — If keeping your personal information out of the business is important, pick a state like Wyoming, New Mexico, or Nevada that has excellent privacy laws. They do not collect ownership information for certain business entities (company's true owners' names and addresses).
  • Investment — If you are seeking outside investors, some will require you incorporate in Delaware because they feel more comfortable with the corporate-friendly business culture.

Disadvantages of Out-of-State Incorporation

  • Double taxation — While the main reason for some business owners to incorporate out of state is lower taxes, they might find out they have to pay taxes in both the state of incorporation as well as their home state.
  • Compliance in multiple states — You are likely subject to double compliance by having to register in both states.
  • Lack of benefits — The benefits big corporations find with incorporating out of state don't necessarily apply to all businesses, or maybe they won't see as much benefit, making out of state incorporation not worth it.

If you need help with whether you should incorporate your online business, you can post your legal need on UpCounsel's marketplace. UpCounsel only accepts the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.