Before diving into the legalities of business as a domain investor, it is important that you know all your options in setting up your business. To better equip you in deciding which structure is apt for your domain portfolio, you need to define your goals and vision for your business.
Are you expecting it to grow bigger and have more investors? Do you want to maintain full control of it? Do you intend to pay lower taxes? How much capital are you putting out for it?
There are different types of business structures that you can apply for your domain investments based on ownership and objectives. But the most common business structures domain investors employ are sole proprietorship, partnership, and limited liability company (LLC).
But did you know that LLC is in itself a legal business entity that combines aspects of different structures? Let us begin by defining a limited liability company and discussing other business formations integrated with it to help you determine the hybrid approach that would best benefit your domain investments.
What is a Limited Liability Company?
A limited liability company is a type of legal entity that combines the features of a corporation and a sole proprietorship or partnership. Owners of LLCs are called members, and like corporations, members are protected from company liabilities and debts.
However, like sole proprietorships and partnerships, limited liability companies do not pay business tax. Instead, income and losses are passed through to members, who file them on their individual income tax returns. An LLC can also be formed for privacy purposes.
In setting up an LLC, most states would require you to have a registered agent. Some members list themselves as the agent, but to keep your personal information private, you may want to hire a registered agent for your legal correspondence.
Although LLCs have different conditions, depending on business ownership and goals, you must keep in mind that all types of LLCs must keep the business activities independent from the personal activities of the members. All transactions and financial records must be kept separate. It is highly recommended to have a different bank account for your domain business as well.
Otherwise, if your business and personal operations are caught intermingled, you may still be held personally liable for your business debts and obligations. This is what is referred to in the corporate world as “piercing the corporate veil.” Another point to remember is that states vary in their requirements and regulations in setting up a limited liability company and electing it to a certain status.
There are notable classifications of an LLC that may be advantageous for your domain investing business. These are single-member limited liability companies (SMLLC), multi-member limited liability companies (MMLLC), and S corporations.
Single-Member Limited Liability Company (SMLLC)
If you are a domain investor who solely owns your domain portfolio, a single-member LLC may be a good choice for you. SMLLC is a blended approach of sole proprietorship and LLC.
Unlike sole proprietorship where you don’t need to register your domain business, LLCs need to register and submit documents depending on the state regulations. But taxation-wise, considering you are the only owner or member, your SMLLC will be treated as a disregarded entity.
All earnings and losses of your domain investments shall be reported on your personal income tax return. And because it is an LLC, your personal assets are shielded from debts and other financial obligations of your business.
If you are just starting with your domain investing business, you may have started with a sole proprietorship. But as your domains, income, and expenses increase, it is better to transform it into a single-member limited liability company. And because you are the only owner, you still have full control of your business.
Furthermore, not only will it safeguard your assets but will also give you more access to funding. Banks and creditors rarely grant loans and credits to unregistered sole proprietors. The LLC status of your business gives it more credibility among creditors and within the domain investing industry as well.
Multi-Member Limited Liability Company (MMLLC)
Since domain names are increasing in value, some domain investors opt to have partners to purchase premium domains. This is the reason why partnerships are not unusual in the domain investing business. To secure your personal assets from the financial and legal liabilities of your company, it is wise to go for a multi-member limited liability company rather than a general partnership.
Multi-member limited liability company or LLC is just an extended version of the single-member limited liability company. It has at least two members which makes it a hybrid structure of partnership and LLC. There is no limit to the number of members an MMLLC can have. Members can be individuals, corporations, or other limited liability companies.
Just like any other LLC, you need to register your domain business according to state requirements. Therefore, you still have to check with your state if you are qualified for this type of LLC.
An operating agreement is important in an MMLLC. It should be made between members to define the ownership structure. Also stated in the agreement are the capital contributions, distribution of gains and losses, management structure, addition and removal of member procedures, and dissolution clauses. It is also vital to state the roles, responsibilities, and voting control of each partner. This agreement is created to avoid future disputes among members.
For taxation purposes, MMLCs are considered to be partnerships. You will have to report your share of income and losses on your personal income tax returns. It is not eligible for paying corporate tax.
Despite the fact that MMLCs provide limited liability to their members, it is crucial that your members are qualified. There are some cases where all members of the MMLLC are held liable for one of its members’ mistakes or negligence.
S Corporation
For a domain investing business on a larger scale, you can have your LLC classified as an S corporation. With this state-elected status, you will have the benefits of having limited liability while avoiding the double taxation that generic corporations experience.
However, there are also certain restrictions for an S corporation. The number of shareholders (owners) must be up to 100 and should be US citizens only. But most domain investing businesses do not reach this number, which makes them eligible for an S corporation status. There must be a board of directors and officers, and annual reports, organizational minutes, and other documents are submitted to the state.
So, why choose an S corporation? It is considered a separate entity from its shareholders, which shields their personal assets. No corporate tax is paid. Income and losses are passed through to shareholders.
In contrast to other LLCs where you need to pay self-employment tax and personal income tax based on your total income, you can write yourself as an employee of your corporation to lessen your self-employment tax. The reason for this is you already have tax deductions in your salary. Your remaining share of profit, which is called a dividend, will also be taxed lower.
But for small domain investments, it may be better to leave it in the single-member limited liability company status. The amount of paperwork and requirements for an S corporation may not be good for your time. You may avoid self-employment tax, but states are very strict on how you distribute your profits to your salary and dividend, as some fraudulently allocate them.
On the other hand, if your domain investing business grew massively, you may talk with an accountant if the savings are worth electing to an S corporation.
Bottomline
Whatever type of business ownership you have, may it be a single-owned or multi-owned domain investing venture, it is smart to have a limited liability company.
While this hybrid business entity may seem costly for small businesses, especially for sole investors, it is worth the money you put out rather than risk your personal assets to business debts and liabilities. You just have to maintain the separation of your business and your personal activities. Moreso, the best strategy of all is to prevent loss and avoid debts altogether.
Another benefit of an LLC is privacy. As a domain investor, you may be protective of your personal information as well. A limited liability company is one way of developing your domain portfolio while maintaining your privacy.
Apart from that, you project a more professional and established domain investing company when you form it into an LLC instead of just a sole proprietorship. This makes you more legitimate and trustworthy to attract more clients. In cases where you need more funding, creditors lean more into LLCs than sole proprietorships, which also makes it easier for you to access loans and credits.
But do not jump into a limited liability company just yet, analyze the structure if it aligns with your goals. Check your state’s regulations with regards to not just setting up an LLC, but also maintaining it. Different states may have different requirements. Some states may have additional fees and taxes for you to pay as well.
Additionally, you may want to consult an accountant, a lawyer, or a tax advisor before implementing any structure for your domain investing business.