If you have an online business, or are thinking about starting one, you should consider forming a limited liability company (LLC). You don’t need to have a formal business entity to start and run an online business, but forming an LLC can provide you with some important benefits.
If you personally own your online business as a sole proprietorship, you and your business are viewed as one and the same. Therefore, you have unlimited personal liability for all of the debts and other legal liabilities of your business. This means that your personal assets, such as your home or personal bank account, could be at risk to satisfy unpaid debts, legal judgments, and other legal obligations of your business. The same holds true if your online business has multiple owners who operate as partners in a general partnership.
On the other hand, an LLC provides its owners with limited liability. Limited liability means that you, as an LLC owner, are not personally responsible for paying LLC business debts that you haven’t personally guaranteed. Instead, only the LLC’s money and assets can be taken to pay for such debts. Creditors can’t touch your personal funds or property like your home.
The limited liability from debts provided by LLCs typically applies only to routine bills for supplies and small items of equipment. You'll likely remain personally liable for larger debts such as business loans. This is because creditors usually require owners of small LLCs without a record of good credit to personally guarantee business loans. Landlords may also require you to co-sign a business lease for your LLC.
LLCs can insulate you from personal liability for injuries suffered by people who are injured by your LLC’s business activities--for example, if an employee injures someone while on the job. If your online business is co-owned by two or more people, forming an LLC will also insulate you from liability for wrongdoing by your co-owners.
It’s important to understand that even if you form an LLC you remain personally responsible for your own wrongdoing, such as committing fraud or injuring someone through your own negligence. For this reason, even if you form an LLC, it’s important to have adequate liability insurance.
An LLC ordinarily does not pay any taxes itself. Rather, any profits (or losses) the LLC business earns are passed through the LLC to the owners’ individual tax returns. For this reason, LLCs are called “pass-through entities.”
LLCs owned by a single person are usually taxed the same as a sole proprietorship (the IRS calls such single-member LLCs “disregarded entities”). You file IRS Schedule C, Profit or Loss From Business, with your tax return listing your business income and deductible expenses. You pay income tax at your individual tax rates on any profit your business earns. This is the simplest tax return you can have when you run a business. If you hire a tax preparer to do your taxes, you’ll pay much less than if you form a corporation.
LLCs with multiple members are ordinarily taxed the same as a partnership. Each LLC member reports on his or her individual tax return (Form 1040) the member’s share of the partnership’s net profit or loss, and pays tax on any profit at individual rates. The LLC files an information return with the IRS on IRS Form 1065, U.S. Return of Partnership Income that tells the IRS about the LLC’s income and deductions for the year.
LLC owners have the option of choosing to be taxed as a regular C corporation or an S corporation. This is easily accomplished by filing IRS Form 8832, Entity Classification Election, and checking the corporate tax treatment box on the form. Choosing C or S corporation taxation sometimes can save LLC owners taxes. See Nolo's article "How LLC Members are Taxed."
LLCs are easy to form. You file articles of organization (or a similar document) with the appropriate state office, usually the secretary of state. The cost in most states is around $100. If your LLC has two or more members, you should also create an LLC operating agreement. The cost for this varies depending on whether you create a custom agreement or use a standardized form. Depending on where your LLC is located, you may also need to obtain other local and state business licenses for which a fee must be paid. For detailed guidance, see Nolo's article "How to Form an LLC."
LLCs have great flexibility in how they are managed: they can be run by their members or elect to be managed by a management group, which can consist of members or nonmembers. Small LLCs are normally member managed and have fewer corporate record keeping responsibilities than corporations. With a corporation, you must hold and record regular and special shareholder meetings to transact important corporate business and even if you’re the only corporate owner, you need to document your decisions. This isn’t required for an LLC.
If you form an LLC to run an online business, it will qualify you for the 20% pass-through deduction. This deduction, which is in effect from 2018 through 2025, allows owners of pass-through business entities to deduct for income tax purposes up to 20% of the net income their businesses earn. LLCs are ordinarily pass-through entities--the business income or loss is passed through the business to the LLC owners' individual returns. Thus, if you earn a profit from your online business, you'll get the deduction.
For example, if net income from your online LLC business is $100,000, you may deduct up to $20,000 from your income taxes. However, if taxable income exceeds an annual threshold, the deduction is limited to 50% of the amount paid to employees of the entity, or 25% of employee payments plus 2.5% of the value of depreciable business property. This deduction may not be taken by shareholders of C corporations. It's one good reason you should organize your online business as an LLC, not a C corporation.
Forming an LLC can cost a bit more than running your online business as a sole proprietorship or partnership. In most states, these costs are not substantial. You have to decide whether these extra costs are worth the benefits provided by the LLC.
Many states impose annual fees on LLCs that you don't have to pay when you're a sole proprietor. This may be called a franchise tax, an annual registration fee or a renewal fee. In most states, the fee is about $100, but California exacts a hefty $800 minimum franchise tax per year from LLCs.
A few states also impose special income taxes on LLCs. This is in addition to the income tax the LLC owners pay. For instance, California levies a tax on LLCs that make more than $250,000 per year; the tax ranges from about $900 to $11,000.
For more information, check the website of your state's secretary of state, department of corporations, or department of revenue or tax. For more state specific information, see Nolo's article LLC Filing Requirements.