Last updated - November 23, 2023
There’s more than one way to boost your e-commerce profits. One option, of course, is to generate more sales, something you can do through effective marketing and advertising strategies. But you can also approach profitability from another angle, minimizing your overall tax obligations to increase your margins.
E-commerce businesses may attempt to minimize their tax obligations in various ways, but one of the best things you can possibly do is to choose the right legal structure for your business. In particular, opting for the LLC structure can yield considerable tax advantages.
What is an LLC?
LLC stands for Limited Liability Company, and it’s the most popular legal structure for small business owners in the United States. What distinguishes the LLC from other structures, such as the Sole Proprietorship, is that it actually creates a wholly distinct legal entity. In other words, the LLC allows you to maintain a line of separation between personal assets and liabilities and business assets and liabilities.
This is advantageous because it provides LLC owners with personal liability protections. There are also some built-in tax advantages… but more on those in a moment.
Starting an LLC is generally considered to be simple, straightforward, and affordable, though requirements can change from state to state. So, before setting up shop in the Sunshine State (for example), it would be wise to consult a detailed guide for Florida LLC formation.
LLC Tax Strategy
Simply registering your LLC is an important first step toward minimizing your e-commerce company’s tax burdens. With that said, there are some additional considerations to help optimize your tax strategy.
Think About Changing Your Tax Classification
One of the big perks of the LLC structure is that it allows you to choose between different tax classifications. In other words, the LLC provides you with autonomy over how you report your income to the IRS.
In most states, LLCs default to pass through tax reporting, just like Sole Proprietorships. This simply means that you report income on your personal tax return, and pay your normal income tax rate. For many small business owners, this is the simplest and most cost-effective option.
Be advised that you may also opt into different reporting terms, however. The LLC gives you the choice to change your tax classification to either S Corporation or C Corporation status. But should you?
- S Corporation classification still lets you be taxed on a pass-through basis, but it may also help you avert onerous self-employment taxes. It can be a good option but it’s not available to all LLC owners, particularly those who need more flexible ownership rules.
- C Corporation classification exposes you to the full corporate tax rate. This is not a popular option among smaller businesses and the self-employed, but in some situations, it may be advantageous as part of a broader, more sophisticated tax strategy.
In either case, it’s advisable to seek counsel from an experienced business tax expert before making any change. Be aware, however, that these options do exist, and are worth exploring as you seek to fine-tune your tax strategy!
Claim the Right Deductions
LLCs have a number of powerful tax deductions they can take, reducing the income they are required to report to the IRS. The simplest of these deductions is the self-employment deduction, basically covering the employer-equivalent portion of your Medicare and Social Security deductions.
However, there are other potent deductions that shouldn’t be neglected. One of the most advantageous is the Qualified Business Income (QBI) deduction. This below-the-line deduction can be a useful tool for reducing overall reportable income; your tax preparer or accountant can provide more information about whether it’s something your LLC qualifies for.
Investigate Self-Directed Retirement Accounts
Self-directed retirement accounts allow you to kill two birds with one stone, both setting aside money for your retirement and reducing your reportable income. Options to consider include the SEP-IRA, Simple IRA, and Solo 401(k).
While each type of self-directed retirement account has its unique pros and cons, the advantages generally include:
- Contributions are fully deductible
- Plenty of control over how you invest your retirement funds
- An overall high level of autonomy over your own financial future
Self-directed retirement accounts can be an essential component of any LLC’s tax strategy.
Deduct Health Insurance Costs
Here’s a critical deduction for LLC owners to keep in mind: The money you spend on health insurance premiums is a valuable write-off; in fact, you can deduct these premiums above the line, the most popular type of tax deduction. Note that this encompasses both medical and dental insurance deductions.
To qualify for these deductions, your LLC must report an actual profit; and, you can’t be eligible for a health plan through your spouse’s employer. Despite these complicating factors, this is still a deduction well worth discussing with your tax preparer.
Offset Income with Losses
A final recommendation for LLC owners: Remember that net operating losses can be used to counterbalance your income from other sources. Here again, there are a few limitations to be aware of:
- For any given year, there is a maximum amount of losses you can apply
- You’re only allowed to shelter 80 percent of your total taxable income
With that said, this is another important option to discuss with your tax person, especially if you’re bringing in losses and profits from multiple sources.
Choosing the Right Tax Strategy for Your E-Commerce Business
As you develop a robust and effective tax strategy, you have a number of options to consider. Foremost among them is the choice of legal structure for your business. For most e-commerce merchants, the LLC structure will offer the widest array of benefits, including important tax advantages.