Choosing a Type of Business

When you're setting up any small businesseBay businesses includedyou first need to decide what type of structure you want your business to have. The different types of businessessole proprietorship, partnership, and corporationeach have their pros and cons, and you should seriously evaluate which structure is best for your individual situation.

Note

I am not a lawyer, nor am I an accountant; I just write books. For that reason, you should take the information in this chapter as general in nature, and consult an appropriate professional for more specific legal and tax-related advice.

Sole Proprietorship

Most eBay businesses are set up as sole proprietorships. In this type of structure, you are your businessand vice versa.

A sole proprietorship is the easiest type of business to form, and the easiest to manage on an ongoing basis. You don't have to file any papers of incorporation, nor do you need to withhold and pay monthly payroll taxes and the like. You file income tax for the business under your own name, using your Social Security number as your tax identification number. You'll file and pay this tax in quarterly estimates (described in the "Dealing with Taxes" section, later in this chapter), but the paperwork burden is minimal compared to other forms of businesses.

On the downside, the owner of a sole proprietorship is personally responsible for the debts and legal obligations of the business. That means if the business owes money, you're personally on the hook for itand if your business gets sued, you end up in court.

Note

For more information about the legalities of starting a small business, check out Business.gov (www.business.gov), the U.S. govern-ment's guide for businesses; the Business & Human Resources section of the Nolo website (www.nolo.com); and the Entrepreneur's Help Page (www.tannedfeet.com). Another good source of information is your local secretary of state's office (or website), which should have all the forms you need to get started.

Registering as a sole proprietorship is relatively easy and relatively cheap. You can probably handle all the paperwork your-selfalthough using an accountant or attorney is never a bad idea. Your business can share your name, or you can do business under an assumed name or dba (doing business as). To do this legally, you'll need to file a fictitious name affidavit in the county in which you do business. If you choose to open a bank account under your business name, you'll need to present this fictitious name affidavit. See the office of your county clerk for specific details.

Partnership

A partnership is like a sole proprietorship, but with more than one owner. The two or more partners have to contractually agree as to who is responsible for what, and how to share the business's profits or losses. You'll definitely want to draw up formal partnership papers, which means bringing in a lawyer. Legal registration is similar to that of a sole proprietorship.

In a partnership, all partners are held personally liable for losses and other obligations. This also means that one partner is liable for the other's actions; if your partner runs up a huge debt or is sued, you can be held responsible.

In addition, breaking up or selling a partnership is often problematic. If one partner wants to quit, the other one(s) has to buy out his or her shareand valuing a business at the breaking point is seldom quick or easy.

A partnership has to file a tax return and must have a Federal Employer Identification Number (EIN), although the business itself pays no income tax. The individual partners report the company's income on their personal tax returns.

A few words of caution, however: If you're thinking of opening an eBay business in partnership with a close friend or family member, know that one of the most effective ways to ruin a good friendship is to go into partnership together. Even the best friendships are tested in the stressful environment of running a day-to-day business. I've seen far too many friendships end up on the rocks because of shared business stresses. It may very well be true that while friends can be partners, partners can never be friends.

Corporation

Almost all large businesses (IBM, Microsoft, Viacom, and so on) are incorporated. Small businesses can also incorporate, although for many, going to the effort is more trouble than it's worth.

One of the main advantages of incorporating your business is that it separates you personally from the business entity. That means your personal liability is reduced if the business falls into debt or gets suedin theory. In practice, however, lenders will often require the owners of small corporations to sign personal guarantees, which pretty much obviates that purported advantage.

Another advantage of incorporating is that if you eventually have to hire additional workers to help you run your eBay business, you can set up health insurance and retirement plans for your company's employees. In addition, if you ever decide to get out of the business, selling a corporation is easier than selling other forms of businesses. Corporations can also sell stock, so if you have dreams of going big time, this is the way to start. There may also be tax advantages of incorporating. Consult your accountant for details.

And, depending on the amount of revenue your business generates, you may pay fewer taxes as a corporation than you would as an individual. At higher levels, you can shield some of your personal income from employment tax by having the corporation pay you a dividend rather than a salary. (Dividends don't have employment tax attached; salaries do.) Of course, any dividends paid to stockholders (that would be you) are still subject to personal income tax. You'll need to consult your accountant to determine which if any tax benefits accrue in your particular situation.

Potentially offsetting this tax savings is the fact that the corporation itself has to pay taxes on its profits. You minimize this corporate tax burden by taking all the profit out of your corporation, typically in the form of a big year-end bonus or dividend to yourself, so that the business has no net profit. It's a numbers thing.

These benefits come at a cost, however, in the form of increased fees and paperwork. At the very least, a corporation must have a Federal EIN and withhold and pay monthly employment taxes for each of its employees. (That's you again.) You'll probably need an attorney or accountant to handle the details for you.

Thee are several types of corporations you can form, the most popular of which is the subchapter S corporation. This type of incorporated business is the simplest to set up, and the profits of such a business aren't subject to corporate taxes. (You're still subject to personal income taxes, of course.) Forming a subchapter S corporation also enables you to offset any business losses against your personal income.

If you have additional investors in your business (besides yourself, that is), you might want to consider filing as a limited liability corporation (LLC). In an LLC, the business's income and losses are shared by all investors, although investors are subject to limited liability (hence the name) for the corporation's debts and obligations.

In addition, several states recognize another form of small business corporation, called a statutory close corporation (SCC). An SCC typically is less formal (and therefore easier to establish) than a typical corporation, with operation similar to an LLC. You should ask your lawyer about the benefits of forming an SCC if you live in Alabama, Arizona, Delaware, Georgia, Illinois, Kansas, Maryland, Missouri, Montana, Nevada, Pennsylvania, South Carolina, Texas, Vermont, Wisconsin, Wyoming, or the District of Columbia.

Note

While it's always good to work with a local attorney, you can complete your incorporation papers online with LegalZoom (www.legalzoom.com). This website lets you create all manner of simple legal documentstypically for a lower cost than you would otherwise.

All this said, most small eBay sellers opt against forming a corporation for their eBay businesses. I can only speak for myself here, but I've found that whatever slight advantages incorporation might offer to a small business are more than offset by the increased paperwork. For an eBay business just starting out, sole proprietorship is probably the way to go.