Most e-commerce entrepreneurs launch their first store as a sole proprietor—uploading products to Shopify, setting up an Amazon storefront, maybe adding a few wholesale accounts. It’s simple, fast, and gets you selling quickly.

This approach is ideal for testing the waters. But as your business becomes profitable, you’ll reach a tipping point where this simple structure becomes a major financial drag. Here’s what no one tells you: once your net profits (after Cost of Goods Sold and expenses) consistently exceed $60,000 annually, staying a sole proprietor can cost you thousands in unnecessary self-employment taxes every year.

Your business structure determines how much you pay in taxes, how your personal assets are protected, and how much administrative work you’ll face as you scale. Choose wrong, and you’ll either overpay the IRS or scramble to reorganize when your business outgrows its original setup.

The Reality: Most Successful E-Commerce Businesses Outgrow Sole Proprietorships

Take Marcus, who started selling outdoor gear through Amazon, his own Shopify store, and wholesale accounts. In year one, he made $85,000 in profit as a sole proprietor. What he didn’t realize? He paid $12,007 in self-employment taxes on that profit. That money could have funded marketing campaigns or inventory growth.

When Marcus switched to an S Corporation election for his LLC in year two, he saved over $8,000 annually in self-employment taxes. That savings funded his first warehouse lease and two part-time employees.

The business structure that works for a $30,000 side hustle rarely works for a $500,000+ multi-channel operation. Here’s how to choose the right structure for where your e-commerce business is today—and where it’s headed.

The Four Main Business Structure Options for E-Commerce

Sole Proprietorship: The Starting Point

What it is: You and your business are legally the same entity. According to the IRS, a sole proprietor is “someone who owns an unincorporated business by themselves.”

Tax treatment: All business income flows directly to your personal tax return on Schedule C. You’ll pay income tax on profits, plus the full 15.3% self-employment tax on net earnings over $400. That 15.3% covers both the employer and employee portions of Social Security and Medicare taxes.

Best for:

• New e-commerce businesses testing product-market fit

• Annual profits under $40,000

• Simple operations (one sales channel, no employees)

Key trade-off: No liability protection and the highest tax burden. Every dollar of profit is hit with self-employment tax.

Single-Member LLC: Protection Without Tax Benefits

What it is: A Limited Liability Company with one owner. For tax purposes, the IRS treats it as a “disregarded entity”—you file the same way as a sole proprietor.

Tax treatment: Same as a sole proprietor. All profits are subject to self-employment tax unless you make a different tax election.

Best for:

• E-commerce businesses with inventory risk or potential liability issues

• Owners who want legal protection but aren’t ready for payroll or complex elections

What changes: Your personal assets (house, car, savings) are shielded from lawsuits and business debts.

What doesn’t change: The tax bill. You’re still paying 15.3% self-employment tax on all profits.

Multi-Member LLCs: The Default for Co-Founders

What it is: An LLC with two or more owners. By default, the IRS taxes it as a partnership — profits and losses pass through to the members’ personal returns via a Schedule K-1.

Tax treatment: Partnership taxation means each member pays income tax and self-employment tax on their share of the profits, unless the LLC elects to be taxed as an S Corporation or C Corporation.

Best for:

• Co-founders who want liability protection and flexibility in profit-sharing

• Businesses not yet ready for the payroll and compliance requirements of an S Corp

Key trade-off: Default partnership taxation doesn’t reduce self-employment tax. Each partner pays the full 15.3% on their share of the profits. To capture the same savings available to single-owner businesses, multi-member LLCs often elect S Corp status once profits are high enough.

LLC with S Corporation Election: The Sweet Spot for Growing E-Commerce

What it is: You form an LLC but then file Form 2553 to be taxed as an S Corporation.

Tax treatment: This is where the savings kick in. Instead of paying self-employment tax on all profits, you:

• Pay yourself a reasonable salary (subject to payroll taxes)

• Take the remaining profits as distributions (not subject to self-employment tax)

The math:

• As a Sole Proprietor: On $100,000 in profit, Marcus would pay $15,300 in self-employment tax (15.3% of $100,000).

• With an S Corp Election: Marcus pays himself a $50,000 salary.

  • Payroll taxes on salary: $7,650 (15.3% of $50,000)

  • Distributions: $50,000 with no self-employment tax

  • Total savings: $7,650 annually

Best for:

• E-commerce businesses with $60,000+ in net profit

• Multi-channel operations (Amazon + Shopify + wholesale)

• Businesses planning to reinvest profits for growth

Key trade-off: The IRS requires you to pay yourself a reasonable salary for the work you perform. This isn’t optional. If you underpay yourself and try to take most of your profits as distributions, it’s a red flag for audit. The IRS has challenged—and won—cases where owners paid themselves as little as $10,000 while pulling six figures in distributions. Penalties can include back payroll taxes, interest, and fines.

Rule of thumb: Your salary should reflect what you’d have to pay someone else to do your job in the business, based on industry norms, duties, and hours worked.

What Counts as a “Reasonable Salary”?

The IRS doesn’t publish a magic formula, but here are the factors examiners look at when deciding whether an S Corp owner’s salary is reasonable:

• Role & Duties – What would you pay someone else to do your job? (e.g., store manager vs. warehouse staff vs. CEO)

• Time Commitment – Full-time owners generally need to pay themselves more than part-timers.

• Industry Norms – IRS agents often reference salary data for your sector and geography.

• Business Profits – If your company nets $250,000, a $20,000 salary will raise eyebrows.

• Owner Qualifications – Experience and unique skills can justify a higher wage.

Bottom line: Pay yourself as if you were hiring someone with your responsibilities in your market. The salary doesn’t have to equal all profits—but it has to pass the smell test.

The Trade-Off: Increased Compliance and Costs

An S Corp saves serious tax dollars, but it’s not free:

• Payroll: You must run payroll (using Gusto, ADP, etc.), withhold taxes, and file Form 941 quarterly and W-2s annually.

• Separate return: S Corps file Form 1120-S and issue K-1s. This is more involved than a sole prop’s Schedule C.

• Bookkeeping: Owners must clearly separate salary vs. distributions.

• State requirements: Some states charge franchise taxes or special S Corp fees.

For many businesses, these costs are well worth it—but you should factor them in before making the switch.

C Corporation: When You're Thinking Exit Strategy

What it is: A separate legal entity that pays its own taxes. The IRS explains that C corporations are "recognized as a separate taxpaying entity."

Tax treatment: Flat 21% federal corporate rate (made permanent under OBBBA). But watch for double taxation: the corporation pays tax on profits, then you pay again on dividends.

Best for:

• Businesses seeking outside investment or VC funding

• Companies planning for acquisition or IPO

• Businesses reinvesting profits rather than distributing them

The trade-off: Higher administrative complexity and double taxation.

Decision Framework: Choosing Your Structure

Annual Profit Under $40,000

• Best fit: Sole proprietorship or single-member LLC

• Why: The self-employment tax savings from an S Corp usually don’t justify the added costs of payroll, bookkeeping, and filing a separate business tax return at this level. Keep it simple until profits are consistent.

Annual Profit $40,000–$150,000

• Best fit: LLC with an S Corporation election

• Why: This is the range where S Corp savings start to outweigh compliance costs. For many ecommerce owners, the net tax savings can be several thousand dollars per year.

• Key step: File Form 2553 within 75 days of forming your LLC—or by March 15th for current-year elections—to lock in the savings.

• For multi-owner LLCs, the same thresholds apply — partnership taxation is the default, but an S Corp election often makes sense once profits are consistently above the $60,000 mark.

Annual Profit $150,000+

• Best fit: S Corporation, with a possible eye toward C Corporation status

• Why: S Corps continue to be tax-efficient, but at higher profits you may want to evaluate whether a C Corporation makes sense for reinvestment or attracting investors (flat 21% tax rate, but double taxation on dividends).

• Next move: Work with a CPA to model both scenarios. What works at $100K profit may not be optimal at $500K.

Pro tip: These thresholds are guidelines, not hard rules. The decision depends on your state taxes, payroll costs, reinvestment plans, and whether you’ll take money out of the business. A good CPA can run the numbers so you’re not leaving money on the table.

Qualified Business Income (QBI) Deduction

One of the biggest tax breaks available to ecommerce owners is the Qualified Business Income (QBI) deduction, also known as Section 199A. This deduction lets many business owners deduct up to 20% of their qualified business profits on their personal tax return. Under the One Big Beautiful Bill Act, the QBI deduction is now permanent.

Who Qualifies?

• Sole Proprietors, LLCs, and S Corporations generally qualify.

• C Corporations do not qualify.

• The deduction begins to phase out once taxable income exceeds certain thresholds (for 2025: $400,000 single / $500,000 married filing jointly).

How Salary and Structure Affect QBI

For sole proprietors and single-member LLCs, the QBI deduction is straightforward: it’s based on your net profit.

For S Corporations, the picture is more complex:

• Salary you pay yourself (W-2 wages) does not count as QBI.

• Distributions (profits after salary) do count as QBI.

• But if your income is above the threshold, your deduction may be limited by the amount of W-2 wages your business pays.

This creates a balancing act:

• Paying yourself too little salary → IRS red flag, potential penalties.

• Paying yourself too much salary → smaller QBI deduction than necessary.

Why It Matters for E-Commerce: E-commerce owners often reinvest heavily in inventory, ad spend, and logistics. By structuring pay correctly, you can capture both the self-employment tax savings of an S Corp election and the 20% QBI deduction, while keeping the IRS satisfied that your salary is “reasonable.”

Planning Tip: Work with a CPA to model different salary/distribution splits. For many ecommerce businesses, getting the QBI calculation right can mean thousands of dollars in extra annual tax savings—money that can be reinvested in inventory, marketing, or growth.

E-Commerce-Specific Considerations

Inventory Accounting: Multi-channel sellers (Amazon, Shopify, wholesale) often juggle complex inventory tracking. LLCs and S Corps generally give you flexibility in choosing accounting methods, including cash or accrual, that can simplify bookkeeping. As your business grows, you may need to adopt more advanced inventory systems (perpetual vs. periodic) to stay compliant and accurate.

State Tax Traps: Not all states treat business structures the same:

• Some don’t recognize S Corporation elections and tax your LLC as if it were a sole proprietor.

• Others impose franchise or gross receipts taxes on LLCs and corporations regardless of profit. Always check your state’s rules before electing S Corp status—especially if you sell into multiple states.

Marketplace Requirements: Major platforms like Amazon, eBay, and Walmart Marketplace often require a business entity to register as a seller. An LLC usually satisfies these requirements while also giving you liability protection. In competitive categories, being a registered LLC can also make your business look more credible to suppliers.

1099-K Reporting (OBBBA Update): Starting in 2025, the One Big Beautiful Bill Act restored the $20,000 and 200 transaction threshold for Form 1099-K. That means casual or low-volume sellers won’t be buried in tax forms for small transactions, but once your ecommerce sales cross that line, your payment processors (PayPal, Stripe, Shopify Payments, Amazon) will report them to the IRS.

Equipment and Warehouse Deductions: If you’re investing in warehouses, delivery vans, or packing equipment, the Section 179 expensing limits were raised under OBBBA to $2.5M (phase-out at $4M). This makes it easier for ecommerce businesses to deduct large purchases in the year they’re placed in service, rather than depreciating them over time.

International Sales & Sourcing: Selling globally or sourcing products overseas? Your entity choice can affect how you claim foreign tax credits and deal with VAT/GST obligations. While LLCs and S Corps work for most U.S.-based sellers, if international operations become significant, it may be worth evaluating whether a C Corporation or separate entity structure is better.

Making the Switch: Timing Your Structure Change

You don’t need to lock in the perfect structure on day one. Many successful e-commerce entrepreneurs start as sole proprietors and evolve their setup as profits grow and operations become more complex. The key is knowing when and how to make the change.

S Corporation Election Deadlines

• File Form 2553 within 75 days of forming your LLC, or by March 15th if you want it to apply for the current tax year.

• If you miss the deadline, the IRS may allow a late election if you meet certain conditions—but don’t count on this as a fallback.

Flexibility for LLCs

• An LLC can elect S Corporation taxation at almost any point, though timing rules apply. For example, a mid-year election means you’ll need to split the year’s books between two tax treatments.

Tax Triggers to Watch

• Changing structures may create tax consequences—such as closing out a sole proprietorship or reclassifying assets—so timing the switch with your CPA is critical.

• If you’re planning a big purchase or anticipating a revenue jump, the timing of your election could affect whether you capture the associated tax benefits this year or next.

Pro Tip: Don’t wait until you’ve outgrown your structure. The best time to make the switch is when profits are consistently above the $60,000 net mark and you have the capacity (or CPA support) to handle payroll and compliance.

For more detail on election timing, filing requirements, and state-specific rules, check out  Town's tax resources for small businesses.

Action Steps for E-Commerce Entrepreneurs

If you're just starting out: Test your concept as a sole proprietor—it’s fast and low cost. Once you have consistent sales and inventory, form an LLC for liability protection and marketplace credibility.

If you’re profitable but still a sole proprietor: Run the math. On net profits above $60,000, an S Corp election often saves thousands in self-employment taxes each year. Those dollars can go toward ads, inventory, or your first hire instead of the IRS.

If you're already structured but unsure if it's optimal: Review your setup at least once a year. A structure that worked at $100K profit might not make sense at $500K, especially if payroll, benefits, or investors are in the mix. Town's quarterly check-ins keep your structure aligned with where your business is going—not just where it’s been.

The business structure you choose today shapes your tax plan, growth options, and even your eventual exit. Don’t wait until “someday.” The right decision now determines how much of your profits you keep—and how much goes out the door to the IRS.

Ready to optimize your E-Commerce business structure? Town's expert CPAs specialize in helping growing E-Commerce businesses navigate entity selection and S Corp elections. We understand the unique inventory and marketplace challenges you face. We'll analyze your specific situation and recommend the structure that maximizes your after-tax profits while supporting your growth plans.

Disclaimer: This content is for educational purposes only and should not be considered personalized tax advice. Tax laws are complex and subject to change, and individual circumstances vary widely. A strategy that works for one business may not be the right fit for another. Always consult a qualified tax professional before making decisions about your entity structure or tax planning. All examples reflect current law, including updates from the One Big Beautiful Bill Act (OBBBA) as of 2025. Future changes may alter these rules.