What Type of Business Structure to Use for an Amazon FBA?
Amazon FBA businesses have become extremely popular in recent years, as they offer an ideal way for new and small businesses to leverage Amazon’s sophisticated logistics network and get themselves off the ground.
Many people start selling their products as individuals on Amazon, and by default simply run their business as sole proprietors. However, there are a few other options available when deciding how best to structure your Amazon FBA business, and the decision can have important implications.
Table of Contents:
- What Is An Amazon FBA?
- Choosing The Right Structure For Your Amazon FBA
- Sole Proprietor For An Amazon FBA
- LLC For An Amazon FBA
- S Corporation For An Amazon FBA
- Which Legal Entity Should You Choose For An Amazon FBA?
What is an Amazon FBA?
Fulfilment by Amazon (FBA) is a service offered by Amazon whereby businesses have access to Amazon’s highly advanced logistics and distribution network.
Sellers on Amazon can opt to have the entire distribution and delivery process of their products handled by Amazon, saving them time and money and helping them grow quickly.
The term “Amazon FBA” is simply used to refer to a business that opts to make use of these FBA services as their primary means of distributing products to consumers.
Choosing the Right Structure for Your Amazon FBA
If you decide to go the route of starting an Amazon FBA business, one of the first choices you will need to make is how best to legally structure your business.
This choice has important implications in the areas of taxation, asset/legal protection, reporting requirements, formation and maintenance costs, and so forth.
The three most popular business structures to use for an Amazon FBA business are:
- Sole Proprietor
- Limited Liability Company (LLC)
- S Corporation
We will discuss each of these types of legal entities in turn and explore the relative advantages and disadvantages of each, with specific reference to their use as an Amazon FBA business.
Sole Proprietor for an Amazon FBA
Sole proprietorship is in fact the default business structure whenever you start a business venture as an individual in the United States. Anyone who is working in a self-employed capacity (e.g., freelancers, digital nomads, etc.) is in fact operating as a sole proprietor by default.
Sole proprietors act as “pass-through” business entities whereby all profits are taxed as regular personal income. They are attractive because they are by far the simplest and easiest type of business to set up, and do not require any separate paperwork to register.
Amazon allows one to sell on their marketplace as either an individual or a registered business, which means you can indeed operate an Amazon FBA as a sole proprietor.
Advantages of Sole Proprietorship
Sole Proprietors are the simplest and easiest type of business entity to form. They require no expertise or complex incorporation requirements. Tax reporting is also straightforward and will be done along with your personal income tax filing.
As a sole proprietor, you can begin selling your product on Amazon immediately without needing to register your business with the state. There are no special licenses or permits required. This is a major benefit if you need to quickly fill a gap in the market or obtain first-mover advantage.
Sole proprietorships are not registered as separate legal entities and therefore have zero registration and maintenance costs outside of normal business operating costs.
Disadvantages of Sole Proprietorship
No liability protection
The major risk of using a sole proprietorship business model is that it does not offer liability protection to the owner, in contrast to an LLC or S Corporation.
A sole propriety is not considered to be a distinct legal entity from its owner, which means that the owner is entirely and personally liable for any debts and legal obligations arising during the course of business.
This is an extremely risky situation to be in as an Amazon FBA business, where litigations are not uncommon. If one of your customers gets harmed while using a product that you sell, they could potentially sue your business.
If you are operating as a sole proprietor, this places your entire personal net worth at risk.
A sole proprietorship may work out to be less tax efficient than forming a separate business entity like an LLC or S Corp.
These more distinguished business entities are able to claim certain tax deductions for business expenses, as well as other exemptions and tax breaks, that an individual running a sole propriety may not be eligible for.
The specific tax rules vary according to the jurisdiction in which you are operating and/or incorporated, but it is generally accepted that LLCs and S Corps are more efficient tax vehicles than a sole proprietor.
While Sole Proprietors offer a convenient and easy way to begin operating as an Amazon FBA business, it is probably better to resist the temptation to take this shortcut.
There are valid reasons why it is better to go through the additional procedures of forming an LLC or S Corp through which to conduct your Amazon FBA business, which we discuss below.
LLC for an Amazon FBA
The most popular approach for structuring an Amazon FBA business is to form a limited liability company (LLC).
LLCs have been used with great effect by small business owners, as they offer many of the same benefits as corporations (such as liability protection, tax efficiency, etc.) along with greater simplicity similar to a sole proprietor.
Advantages of an LLC
The main advantages of an LLC are limited liability protection and tax reduction. We will explore the importance of each of these in turn for an Amazon FBA business:
Limited liability protection
the primary benefit of an LLC is that it protects the owner/s from liabilities arising during the course of business. An LLC is a separate legal entity, which means that it can be sued in its own name and is responsible for its own debts and obligations.
If someone sues your business for selling harmful or defective products on Amazon, your personal assets will be safely at arm’s length (except in rare circumstances where you have directly and personally caused harm to a customer).
LLCs have different tax rules and obligations to a sole proprietor which is taxed the same as an individual. In most states, the corporate tax rates which apply to an LLC are more favourable than personal income tax rates.
There are also certain business expenses which can be deducted from an LLC’s tax filings. You can use the structure to your advantage by writing off your Amazon VA salary as a business expense if it is below a certain threshold, and therefore pay overall lower taxes by distributing the income across your personal and business tax filings.
Converting your LLC to an S Corporation can have even greater tax benefits.
LLCs are flexible business entities, and offer various ways to customise the business structure to your needs.
An example is flexible profit sharing, where you can divide the LLC’s profits among its members as you prefer and agree upon. These options are more limited in the case of a corporation.
Disadvantages of an LLC
There are not many disadvantages of an LLC to speak of. It is generally a highly efficient and practical business structure to use as an Amazon FBA. Compared to a sole proprietor it is has the following shortfalls:
An LLC is actually a relatively simple type of business entity to setup and the formation process is easy and affordable in most jurisdictions. However, it cannot compare to the complete simplicity of a sole proprietorship.
Unlike a sole propriety, forming an LLC will require a registration process with the submission of necessary documents and a waiting period.
Forming and maintaining an LLC comes with additional costs that do not apply to a sole propriety.
That said, these costs are generally quite low depending on the state in which the LLC is formed. Setup costs can be as little as $45 and maintenance costs are usually under $100 a year.
Less tax savings than S Corporation
A default LLC structure that has not been converted to an S Corporation is liable to pay both income tax and self-employment tax.
The latter is a tax for Medicare and social security, and is charged at 15.3% for profits up to $143.8k per year and an additional 2.9% of taxable income above this limit.
In contrast, an S Corporation only pays self-employment tax on the salary portion of net income.
An LLC is an excellent choice of business structure to use for an Amazon FBA. It offers a simple and cost-effective solution while providing important benefits such as limited liability protection and tax reductions.
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S Corporation For an Amazon FBA
A Subchapter Corporation (S Corp) is seen as a special type of corporation or LLC with a pass-through taxation mechanism. In actual fact, an S Corp is not technically its own type of business entity, but is a tax status that is granted to either an LLC or C Corp.
This means that the decision really comes down to whether to use a default LLC structure for your Amazon FBA or file to have it be granted S Corp tax status.
Note: While you can also use a traditional C Corporation for your Amazon FBA business, it is not at all recommended due to high corporate tax rates, formation costs, and additional complexity.
Advantages of an S Corporation
Taxed more efficiently
The primary advantage of an S Corp over an LLC and other business structures is that it is taxed more efficiently. An S Corp can pay significantly less self-employment tax and therefore lower its overall tax liability.
Only pays self-employment tax
An S Corp only pays self-employment tax on the salary portion of its net income, whereas an LLC pays on its entire profits. Depending on your total income and how you decide to distribute it, this can result in significant tax savings which can then be reinvested into the business for further growth.
S Corporations provide many of the same advantages of traditional LLCs, such as limited liability protection, cost efficiency, etc.
Disadvantages of an S Corporation
Electing to be taxed as an S Corporation can provide significant tax advantages, but it does have its downsides too:
It is more difficult to set up than an LLC, as it involves extra registration steps, paperwork, and additional fees.
There are higher annual maintenance requirements and costs.
There are strict requirements to qualify as an S Corporation which must be adhered to. As such, S corps are heavily scrutinised by the IRS. There are stricter profit-sharing rules and limitations. Tax filing and payroll reporting is more complicated with an S corp. The owners/members of S corps must be residents.
S Corporations are the most tax-efficient business entities to use for an Amazon FBA business, and offer all the same advantages as an LLC in terms of limited liability protection, privacy, etc.
However, they do come with a payoff in terms of the additional layers of complexity and costs to operate. It is up to each individual business owner whether these inconveniences are worth going through for the tax savings that come with an S Corp, and whether they would qualify for S Corp status in the first place.
In most cases, it is worthwhile taking the extra step if it is possible to do so.
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Which Legal Entity Should You Choose for an Amazon FBA?
The choice of business structure for your Amazon FBA really comes down to individual circumstances and preferences. Starting to sell immediately as a sole propriety is the hassle-free route, but leaves you exposed to liability risk and can be tax inefficient.
Opting to go the extra step to at least form an LLC is recommended in most cases, as it will give you much greater personal liability protection, and enable you to lower your taxes through business deductions and other means available to separate business entities.
Finally, you could opt to take the extra steps needed to register your LLC as an S Corporation and in doing so get access to even greater tax savings. This final option involves the most steps and complexity, but can certainly be a worthwhile move for many.
While deciding how to structure your Amazon FBA as well as going through the process of incorporating, it is highly recommended to consult with an expert who can advise you on the ideal structure for your personal situation, and help you with each step of the registration process.