Should I Start an LLC for My Dropshipping Business?

Starting a limited liability company (LLC) for your dropshipping business can provide several benefits.

Most importantly, an LLC structure offers limited liability to its owners, which can protect their personal assets from lawsuits and creditors.

For a dropshipping business, lawsuits can arise from things like a customer claiming they received a faulty or malfunctioning product, false advertising allegations, and refund requests.

LLCs are also affordable, highly flexible (from a tax point-of-view), and can make your dropshipping business seem more credible.

Recommended: Use Northwest to form an LLC for $29 (plus state fees).

Should I Start an LLC for My Dropshipping Business?

Do I Need an LLC for a Dropshipping Business?

Even if you started your Dropshipping account as a hobby, one viral video can quickly gain you thousands of followers (or more). More attention on your videos can create potential risk that you might not have considered. LLCs are a simple and inexpensive way to protect your personal assets and save money on taxes.

You should start an LLC when there's any risk involved in your business and/or when your business could benefit from tax options and increased credibility.

LLC Benefits for a Dropshipping Business

By starting an LLC for your Dropshipping business, you can:

Protect your savings, car, and house with limited liability protection
Have more tax benefits and options
Increase your business’s credibility

Limited Liability Protection

LLCs provide limited liability protection. This means your personal assets (e.g., car, house, bank account) are protected in the event your business is sued or if it defaults on a debt.

Dropshipping businesses will benefit from liability protection because of the inherent liability that comes with selling products online.

Example 1: You took out a large loan in order to finance the startup of your dropshipping business. However, after your business severely underperforms, you realize it will not be able to repay this loan. As a result, the creditor brings a lawsuit against your business for defaulting on this debt. Limited liability would protect you from being held personally responsible.

Example 2: In one of the marketing campaigns your dropshipping business published, an employee writes a joke about a competitor that becomes a big internet meme. As a result, the competitor sues your business on the basis that its actions led to a serious negative effect on its reputation. In the following legal proceedings, your personal assets would be protected from any liability imposed on your business.

Example 3: While showing an investor around your dropshipping business, he trips over some boxes and breaks his ankle. This prompts the injured party to sue your business for the bodily harm he alleges he suffered due to your business’s negligence. If the court found your business liable to pay damages, these could only be imposed on the business’s assets themselves.

Example 4: A damaged product causes injury to a customer, and they sue your business for damages.

An LLC will also protect your personal assets in the event of commercial bankruptcy or loan default.

To maintain your LLC's limited liability protection, you must maintain your LLC's corporate veil.

LLC Tax Benefits and Options for a Dropshipping Business

LLCs, by default, are taxed as a pass-through entity, just like a sole proprietorship or partnership. This means that the business's net income passes through to the owner's individual tax return.

The business’s net income is then subject to income taxes (based on the owner's tax bracket) and self-employment taxes.

Sole proprietorships and partnerships are taxed in a similar way to LLCs, but they do not offer limited liability protection or other tax options.

S Corp Option for LLCs

An S corporation (S corp) is an IRS tax status that an LLC can elect. S corp status allows business owners to be treated as employees of the business (for tax purposes).

S corp tax status can reduce self-employment taxes and will allow business owners to contribute pre-tax dollars to 401k or health insurance premiums.

The S corp status requires that the business pay the employee-owner(s) a reasonable salary for the work they perform.

In addition, the business might need to spend more on accounting, bookkeeping, and payroll services. To offset these costs, you'd need to be saving about $2,000 a year on taxes.

We estimate that if a Dropshipping business owner can pay themselves a reasonable salary and at least $10,000 in distributions each year, they could benefit from S corp status.

You can start an S corp when you form your LLC. Our How to Start an S Corp guide will lead you through the process.

For questions about tax solutions for your dropshipping business, we recommend scheduling a free tax consultation.

Credibility and Consumer Trust

Dropshipping businesses rely on consumer trust. Credibility plays a key role in creating and maintaining any business.

Businesses gain consumer trust simply by forming an LLC.

A growing business can also benefit from the credibility of an LLC when applying for small business loans, grants, and credit.

Northwest will start an LLC for you for just $29 (plus state fees).

Get Started

How to Form an LLC

Forming an LLC is easy. There are two options for forming your LLC:

You can hire a dependable LLC formation service to set up your LLC for a small fee
Or, you can choose your state from the list below to start an LLC yourself

Select Your State

For most new business owners, the best state to form an LLC in is the state where you live and where you plan to conduct your business.

Do LLCs Need Insurance?

As is true for all businesses, LLCs need to own insurance in order to protect their assets. This is especially true for dropshipping businesses.

The difference between insurance and limited liability is in the type of asset each protects. Insurance protects business assets while limited liability protects personal assets.

Common Situations Business Insurance May Cover for a Dropshipping Business

Example 1: After visiting your place of business, a client leaves through your front door, trips on a broken piece of sidewalk, and demands you pay for her medical treatment. General liability insurance would cover her medical bills.

Example 2: Claiming your last marketing campaign libeled its business, a competitor sues your company. General liability insurance would cover your legal defense fees.

Example 3: While pushing a dolly to a third-party delivery truck, you slip on some gravel and accidentally drive the dolly into the side of the truck, causing moderate damage. Your general liability policy would cover the truck’s vehicle repair costs.

Other Types of Coverage Dropshipping Businesses Need

While general liability is the most important type of insurance to have, there are several other forms of coverage you should be aware of. Below are some other types of insurance all dropshipping businesses should obtain.

Commercial Property Insurance

You made a major investment in your business equipment and supplies. If you own the building in which you operate, commercial property insurance would cover the cost of repairing or replacing your business-related property in the event of a fire, burglary, or natural disaster. This includes structural damage to your building or grounds as well as any equipment or supplies you store there.

Professional Liability Insurance

While you strive to help customers ensure the safe, timely shipment of their packages, there’s always a chance someone might decide your services caused them or their business harm. If a customer sues you based on your services or advice, professional liability insurance would cover your legal costs.

Commercial Auto Insurance

Any vehicle you use primarily for business requires commercial auto insurance to protect the vehicle, driver, and others on the road in the event of an accident. Be sure to select a policy that covers not only accident-related vehicle repair costs and medical treatment for anyone injured but also sufficient protection for any business materials you carry in your vehicle.

Workers’ Compensation Insurance

If you hire any employees for your dropshipping business, most states will require you to carry workers’ compensation insurance for both part-time and full-time workers. This coverage protects your employees if they become injured at work or fall ill after a work-related accident. It not only covers an employee’s medical bills and lost wages if they need time to recover but also any disability or death benefits stemming from a work-related accident.

Should I Start an LLC FAQ

Choosing the right business structure depends on your business’s unique circumstances and needs. However, unless your business is very low risk (like a hobby), an LLC is likely the better option.

Visit our LLC vs. Sole Proprietorship guide to learn more.

At a minimum, you’ll need general liability insurance for your Dropshipping business.

While you can start a dropshipping business from scratch for a minimal upfront cost, you are also able to purchase an existing one from between a few hundred to a few thousand dollars. If you start your business from scratch, the only substantial costs will be the price of the goods you will sell, plus your website and hosting.

Visit our How to Start a Dropshipping Business guide to learn more about the costs of starting and maintaining this business.

Dropshipping businesses make money by buying products for wholesale prices and selling them for marked-up retail prices.

A dropshipping business sells products that are shipped by a third-party supplier for marked-up prices. Dropshipping can be quite profitable if you put in the necessary effort and select the right products to sell.