Entity Structure and S-Corp Strategy for eCommerce Owners

By Paul S. Rafelson, Founder, Rafelson Law PLLC

What decides the right structure?

• Who the owners are. Individuals, other companies, trusts and non-U.S. persons are treated differently, and an S election has eligibility limits.
• How profit is taken out. Distributions, salary and reinvestment are taxed differently under each structure.
• What comes next. Outside investors, equity for key people, a sale of assets or of equity and a move into new products or countries.
• Where the business operates. State rules, state taxes and sales-tax registrations vary.

What is the S-corp question?

An LLC or a corporation elects S corporation tax treatment by filing IRS Form 2553, if it meets the statutory requirements. The election has a filing deadline early in the tax year, and a late election needs IRS relief. Timing decides whether the election covers this year or next. The corporation must be a domestic corporation with no more than 100 shareholders, counting a family as one, only eligible shareholders (generally individuals, estates and certain trusts, but not nonresident aliens) and one class of stock (26 U.S.C. § 1361(b)). The election matters because profit paid as distributions avoids self-employment tax, while salary does not. The owner must take a reasonable salary first, and the IRS can reclassify distributions as wages, with payroll tax and penalties, when the salary is too low. The right split depends on your profit, your state and your growth plan, and we set it with your CPA. The election also limits later flexibility, such as bringing in an investor who is not an eligible shareholder, so decide it with the growth plan in mind.

How do the common structures compare?

This table is a starting point, and it leaves out state taxes and many exceptions. Paul S. Rafelson holds an LL.M. in Taxation from NYU, and the firm advises on the tax side of deals.

Can I change the structure later?

Often yes, but a change can have tax and contract consequences: converting an entity, adding an owner, moving assets into a new company or revoking an election. Marketplace accounts, supplier contracts and loans may restrict assignment or require consent. Change the structure ahead of a sale or investment when possible, because buyers and investors look at the history. See holding companies and ownership structure and the M&A Hub (Exits & Brand Acquisitions).

What about foreign owners?

A nonresident alien cannot hold S corporation shares, and neither can a corporation, partnership or LLC taxed as a partnership (26 U.S.C. § 1361(b)). A non-citizen who is a U.S. tax resident qualifies. U.S. entities with foreign owners may have additional reporting duties. The structure should be chosen with the owners’ tax advisers in both countries. See LLC and company formation.

How do I get started?

Contact us. Tell us the owners, how the business is taxed now and what you plan next, and we will tell you whether we can help.

Paul Rafelson is admitted in Florida and New Jersey. Katie Dariano is admitted in New York. For a matter governed by another state’s law, or in another state’s courts, we bring in local counsel or seek admission as the rules require.

Frequently asked questions

Related pages

Sources and notes

• 26 U.S.C. § 1361(b) (S corporation eligibility); 26 U.S.C. § 1202 (qualified small business stock); IRS entity classification rules (26 C.F.R. § 301.7701-3); Fla. Stat. § 605.0304(2) (failure to observe LLC formalities is not, by itself, a ground for member liability); state statutes.