Domain investors usually start as solo entrepreneurs. For someone new in the business, you may be thinking of the best structure to start your own domain investing business. There are two types of business structures that would benefit single owners. These are sole proprietorship and single-member limited liability company (SMLLC).
By reading this article, you will learn more about these two types of business formations, including their advantages and disadvantages, helping you set up a domain investing business as a sole proprietor. This is to help you to decide which of these would best suit your investments and goals.
What is a Sole Proprietorship?
If you are starting your domain investing business, you may consider having sole proprietorship as your business structure. In fact, you may be running it already without you knowing it.
If you have not yet set up a limited liability company or a corporation, but have started operating your business, you are already considered to be a sole proprietor. It is the simplest form of business structure that most domain investors apply during start-up. It is unincorporated and has a single owner.
With this kind of set-up, your business is not separate from you. For this reason, your business assets and liabilities are intermingled with your personal assets and liabilities. Your business income is taxed through your personal income.
How to Set Up a Sole Proprietorship
With sole proprietorships, the owner doesn’t need to file any document to register it. However, if you want your domain business to have a different trade name than using your own name, you may have to file a fictitious business name statement. Check with your state for any restrictions they may have in creating “doing business as” (DBA) names. Some states may also require you to apply for a license or permit.
On the other hand, it is better to apply for a license to operate whether it is required or not. It projects professionalism and legitimacy of the business. Plus, it may also benefit you in tax deduction eligibility in the long run. Also, filing fees are minimal compared to other business structures.
If you opt to be a sole proprietor, your Social Security number may be used as your tax ID. But you are also permitted to get an Employer Identification Number (EIN) from the IRS for your business.
Aside from having more privacy than using your Social Security number, it is also needed when you start to hire employees. Taxation wise, your income from your domain investments is taxed through your personal tax returns. Operating expenses are deducted from your income and then taxed with your usual income tax rate. You will also have to pay self-employment tax for Medicare and Social Security taxes.
Pros of a Sole Proprietorship
- Simplicity: It is the easiest structure to start or operate your domain investing business. No business registration is required, unless you prefer a DBA name, which requires registration. Since you are the sole owner of the business, you may have minimal paperwork that needs to be done compared to other structures.
- Cost: No obligatory annual filing fees to be paid. There are also no mandatory yearly meetings to be held. State registration and filing fees are significantly lower for a sole proprietorship than other business models. This is the reason why it is often the choice for domain investors with less capital to invest.
- Control: Since you went solo on your domain investing business with sole proprietorship, you have 100% control over it. All daily decisions, operations or financial wise, will be in your control. Profits your business gains will also be solely yours.
- Maintenance: In addition to not having to file annual fees to maintain the business, you won’t be spending a lot of your time doing reports and other paperwork, which is compulsory in other types of structure. Dissolving the business is also easy. Once you decide that you no longer want to continue it, you just have to cancel the licenses and permits related to your domain investing business.
- Tax Filing: Filing an income tax return is as easy as filing your personal income tax return, with the use of the Schedule C form. You don’t need to file a separate income tax return for your business. All income and expenses are passed through to your personal income tax return.
Cons of a Sole Proprietorship
- Liability: As mentioned above, sole proprietorship does not separate the business from its owners. This means that the owner is responsible for all financial obligations and legal liabilities of the business. Since your assets are not separate from business assets, it can be seized as payment for unpaid debts.
- Funding: Banks and other creditors are usually hesitant in lending money to a sole proprietor. Even if granted, you may be forced to use your personal assets as collateral. Because of this, loans and credits cannot be your only option in funding the business.
- Credibility: Sole proprietorships have less credibility than other business formations. Firstly, it does not have a business registration and prospective clients might see this as unprofessional. It may also lead you to be behind your competition that are well-established and that are more organized in structure.
- Lifespan: The lifespan of a sole proprietorship business depends on the lifespan of the owner as well. The business dies with its owner.
What is a Limited Liability Company (LLC)?
As a single owner of your domain investing business, you also have the option of forming a limited liability company as a sole proprietor. Owners of an LLC are called members.
A single-member LLC (SMLLC) is a business entity formed within state regulations with the benefit of passed-through taxation and limited liability protection. This means that the owner’s personal assets are protected from business liabilities and debts. It is because the business and the member are considered to be separate entities.
On the flip side, business income for tax purposes are passed through to the member. Just like in sole proprietorship, income from the business is taxed through the member’s personal income tax return.
How to Set Up a Limited Liability Company (LLC)
Setting up a limited liability company involves more paperwork than sole proprietorship. However, states may vary in their regulations and requirements in forming an LLC. Three of these requirements are usually the following:
- Articles of Organization : This contains the basic information of your business, such as business name, contact details, start and end dates, member details, etc.
- Operating Agreement: It is a document that indicates the decision-making process of the business, and other procedures related to it, like the system in adding or removing a member.
- Initial Report: Similar to the annual report LLCs need to file, the initial report contains the names of those running the business, the place of operations, the line of business, the name of the designated registered agent (who can also be the owner), etc.
Depending on the state where you will register your domain investing business, registration filing fees range from $50 to $500. This is aside from the annual filing fee.
A single-member LLC is considered as a “disregarded entity,” and is treated as a sole proprietorship in terms of taxation. Business income, minus the expenses, are taxed through the member’s personal income tax return. Self-employment tax is also paid in an SMLLC.
Pros of an LLC
- Limited Liability: Your personal assets and bank accounts are protected when you choose to form an LLC. Because your business is a separate entity, creditors are not permitted to go through your personal assets. Legal liability is also shouldered by the company. If a client decides to sue, the case will be filed against the business name and not your name.
- Tax Filing: Since a single-member limited liability company is treated as a “disregarded entity,” tax filing is just like filing tax for a sole proprietorship. There is no need to file for separate business tax return.
- Structure Flexibility: If your business grows, you can transform your structure from a SMLLC to LLC partnership or corporation. You just need to abide by the state regulations for election of business status.
- Credibility: A limited liability company presents more formality and credibility than sole proprietorship. A business with this structure is required to have “LLC” on its business name. This increases your chances of getting loans from creditors and attracting more clients.
Cons of an LLC
- Cost: Forming an LLC is more costly than forming a sole proprietorship. Aside from the required business registration, licenses, and permits, there are also annual filing fees to pay to maintain your LLC status.
- Maintenance: To keep your limited liability advantage, you must maintain the separation between your business assets and personal assets. All transactions must be recorded and kept separate. This is to establish the fact that they are independent of one another. Otherwise, it might lead creditors to “pierce through the corporate veil.” By proving and claiming that your business and personal activities are intermingled, creditors are then allowed to go through your personal assets.
- Paperwork: Recordkeeping is a must for an LLC. This is to support the separation of it from the member’s personal activities. Annual reports are also submitted to the state to keep its status. Company information must always be updated as well. These are apart from the documents you need to file for registration when setting it up.
Key Takeaways
If you’re a domain investor with less capital and have no other employees to start with, it may be smart to choose a sole proprietorship structure. In fact, you may be running it already as you start to purchase and sell domains.
With sole proprietorship, you have complete control of your business and you are entitled to 100% of the profits. However, as your domain investing business grows, you may want to transform into a single-member limited liability company.
This will protect you and your personal assets from financial and legal liabilities, with the benefit of being treated as a sole proprietorship in taxation. Although it may seem more costly, it will still be advantageous in the long run as expenses may increase and funding is needed from outside sources.
More importantly, if you plan to grow and expand your sole proprietorship domain investing business, it is still favorable to consult a business advisor before restructuring it.