Forming a Legal Entity

Q: "Do I need to form a legal entity, such as a corporation or limited liability company (LLC), to sell on eBay?"

A: It depends. The vast majority of eBay sellers are sole proprietorships and informal partnerships of friends or family members, who have never felt the need to incorporate their business on eBay.

A sole proprietor is simply a human being over the age of twenty-one with a pulse who is engaged in a trade or business. You don't need any legal paperwork to form one (other than a birth certificate that hasn't been revoked), although most states require you to file a document called a trade name certificate or DBA certificate (for "doing business as . . .") with your town or county clerk's office if you are doing business using a name other than the one appearing on your birth certificate. So, for example, "Clifford R. Ennico, Attorney at Law" is not a trade name; "Cliff's Antiques" is a trade name.

A partnership is two or more human beings engaged in a trade or business and sharing in the profits and losses of that business. Believe it or not, you don't need any legal paperwork to form one—you can become partners with just a handshake. Sometimes you can even form partnerships by accident, as we'll discuss in Chapter 2. When you're in a partnership, you are required to file IRS Form 1065 (partnership tax return) by April 15 each year—unless the sole partners are a husband and wife, in which case you would file Schedule C on Form 1040 each year. Each partner reports as income his or her percentage share of the partnership income and pays taxes on it. So, for example, if you and I are fifty-fifty partners and our partnership made $100,000 in eBay profits last year, you report $50,000 as income on your tax return and I report $50,000 as income on mine.

Generally, there are three reasons for forming a legal entity such as a corporation or LLC:

• You need protection from liability in the event you are sued because of something you did or didn't do on eBay.

• You are looking to raise outside capital from investors, and they will only invest in a legal entity.

• Because a corporation's income is taxed at a lower rate than an individual's name, you are trying to shelter some of your eBay income from taxes.

Q: "How do I pick the right legal entity for my eBay selling business?"

A: Appendix G to this book is a multipage outline, called "Demystifying the Business Organization," that I have been handing out at my legal and tax seminars for over fifteen years. Sit down tonight with a pot of strong coffee (or a V.S.O.P. brandy) and read Appendix G from start to finish. I guarantee you will come away knowing as much as most attorneys do about partnerships, corporations, Subchapter S corporations, limited liability companies, and the differences between them.

Should you ever lose your copy of this book, the outline is also available as a free download from my website at cliffennico.com.

Q: "Should I incorporate in Delaware or Nevada? I've heard you can save money on taxes there."

A: Unless your business on eBay is physically located in Delaware or Nevada, there is absolutely no advantage in incorporating there. A lot of people think they can avoid paying their state's business taxes by incorporating in one of these states. Not true. If you form a corporation in Delaware or Nevada, but are actually doing business in State X (you have an office or mailing address there, for example), you have to qualify your entity as a foreign corporation or foreign LLC in State X and register for State X's business taxes. Fail to do this, and you are operating an illegal, unregistered business in State X—if State X's tax authority catches you several years down the road, you will have to pay all back taxes you owe to State X, along with interest and penalties for late payment, and a possible referral of your business to your state attorney general's office for criminal prosecution.

I don't want to scare you, dear reader, but there are a lot of evil people out there on the Internet selling you the idea that you can form a corporation in Nevada for only $100 and (this is never stated explicitly, only suggested, to avoid outright fraud) avoid paying business taxes anywhere else. It simply isn't true. If your eBay selling business is located in State X and you want to form a corporation, LLC, or other legal entity, the only place to incorporate is in State X. Period. End of story. World without end. Amen.

 
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