Should I Start an LLC for My 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.