LLC and Company Formation for eCommerce Businesses

By Paul S. Rafelson, Founder, Rafelson Law PLLC

How do I choose between an LLC and a corporation?

Most eCommerce businesses with a small number of owners choose an LLC for its flexibility. An LLC’s tax treatment is a default that can be changed: a single-member LLC is generally disregarded for federal income tax, a multi-member LLC is taxed as a partnership by default and either can elect to be taxed as a corporation. A corporation fits when the business expects outside investors, stock options or a future sale of stock, and a corporation can elect S status only if it meets the eligibility rules, which include a limit of 100 shareholders and no nonresident alien shareholders (26 U.S.C. § 1361(b)). The tax side is covered on our page on entity structure and S-corp strategy.

Which state should I form in?

The usual choices are the state where the owners live and operate, or Delaware. Forming in a state other than the one where the business operates generally means registering as a foreign company in the operating state too, so it often adds a second set of filings. The choice depends on where the owners, inventory, employees and bank accounts are, on the owners’ agreement and on whether investors expect a particular state. Sales-tax registration duties come from where the business sells and stores inventory, not from where it was formed.

What goes wrong at formation?

Most business owners form the entity in minutes online and then open Amazon, the bank and the trademark in the wrong name or the wrong order. A state name check clears the entity name in one state only. It does not clear the brand, and a trademark filed by the wrong entity has to be refiled. We form the entity and sequence the accounts, the brand filing and the owners’ agreement to avoid unwinding anything before a sale.

What if an owner lives outside the United States?

A non-U.S. owner can generally own a U.S. LLC or corporation, and the setup affects taxes, bank accounts and reporting. An S election, for example, is not available if a shareholder is a nonresident alien. A foreign-owned single-member LLC and a U.S. corporation with a 25 percent foreign owner each file IRS Form 5472 every year, with a $25,000 penalty for a missed form. A foreign-owned multi-member LLC files a partnership return and withholds tax on the foreign owners’ share. The owners’ own countries have rules too. A company formed abroad and registered in a U.S. state also files a beneficial ownership report with FinCEN, listing its non-U.S. owners only. We coordinate with the owners’ tax advisers on those points, and the structure is set up together with the ownership structure.

Why good standing matters

A company out of good standing loses the right to sue, shows up in a buyer’s diligence as a defect and fails bank and marketplace verification. Missed annual reports, stale agents and skipped foreign registrations cause most of it. We keep the calendar and clean up what was missed. Cleaning up missed filings is part of ongoing business counsel.

How does formation connect to the brand?

Whichever entity owns the brand should hold the trademark application and sign the supplier, designer and photographer agreements, so that ownership is clean for Brand Registry and for a later sale. Form the right entity before you open accounts. Amazon has a process to change the legal entity on a seller account, and we handle account transfers in sales and restructurings. Getting it right at the start saves a step.

How do I get started?

Contact us. Tell us the owners, where the business sells and whether anyone lives outside the United States, 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); IRS Form SS-4 and Form 5472 instructions; state LLC and corporation statutes; FinCEN beneficial ownership information reporting rule (31 C.F.R. § 1010.380), as amended.