One of the most frequently asked questions I get, either at a seminar or through email, is about what type of entity should be used for a start up business. I'm glad people are thinking about this, because the types of entities you use are at the core of a successful tax strategy. Yesterday, I received a question in this regard from Charlie, one of our School of Tax Strategy members.
Q: Hi Tom, It's Charlie again. I just thought of another question. My fiance Tiffany and I started selling on eBay. So far we have sold 27 random items around the house. The profit margin is a joke, no more than $100. Anyhow, we are going to be transitioning to drop shipping through eBay. Which means, selling warehouse items through an outside source, and they take care of shipping and handling. All we do is find the items we want to sell and advertise them. We want to go full scale on that, and generate thousands per month. My question is, when should we set up an entity, if we should at all? and whether or not setting up an entity would be the best tax strategy for us. Are we behind on doing that? What are the action steps around that? Tiffany and I are brand spankin new to business, so please guide us in what would be the most tax and cost effective way of running our eBay selling business.
A: It's never too early to set up an entity for your business, so get started right away. The choice of entity depends of several things. For example, what state or states you will be operating in? How big to you plan on growing your business? How fast do you expect your business to grow?
The best answer to entity choice is always to determine your entity within a comprehensive Tax Strategy. Your Tax Strategy should include not only your choice of entity, but how you plan to operate the entity, your goals for the business and even your exit strategy. A simple way to begin is to form an LLC, or limited liability company. In most states, this is a good entity to form. The best thing about an LLC, outside of it's asset protection characteristics, is its flexibility from a tax standpoint. An LLC can be taxed as a sole proprietorship, a partnership (if two or more members), a C corporation or an S corporation.
Until you actually do your tax strategy, just set up the LLC along with a bank account and bookkeeping (we recommend Quickbooks Pro for start up companies). When you meet with your CPA to do your tax strategy, you can make changes to how the LLC is taxed, if necessary.
Remember that a good tax strategy is the first step to increasing your cash flow by lowering your taxes. And it takes good cash flow to develop lasting wealth. With lower taxes, strong cash flow, and wealth, your financial freedom is closer than you think.
Tom