Legal Structure

Should the ecommerce business be run through a separate legal entity?

Some businesses choose to organize a separate legal entity through which they will organize and operate their ecommerce operations or online stores. The reasons for using a separate entity include possible tax savings, mitigation of liability by shifting liability for online operations away from the existing business, and separation of a consumer sales division from research and development or manufacturing arms of a company.

Nevertheless, the separation between the online business and an offline business from which the online business grew may raise logistical problems. If buyers exchange goods purchased online in a physical store, or return goods to a processing center that is not part of the online business, then the legal separation between the online business and the brick and mortar business may lose its distinction.

What form of entity can the online business choose?

Ecommerce businesses may be formed through a variety of legal structures. Like other new businesses in the United States, most will probably be organized using the corporate form, a partnership or a limited liability company. Most new businesses are organized within the corporate or limited liability structure to help the founders shield other business and personal assets from potential liability. Using a limited liability or a corporate structure for a new online business, the founder will be able to shield personal and other business assets from exposure to the online business’s liabilities to the greatest extent possible.

What tax issues affect my choice?

An ecommerce business may be segregated in a distinct legal entity to avoid sales tax liability. Sales generated by an entity that is located in a particular state may not be subject to sales tax collection obligations there if the purchaser resides in another state. The sales tax liability technically falls on the consumer in this example (see Taxes – Do I need to collect sales taxes? below.) If the online business is located in a jurisdiction that does not impose sales tax (Oregon and New Hampshire, for example), then the business will avoid the obligation to collect sales tax in its home state, as well.

In addition to considering sales tax implications, many online businesses seek to minimize taxes by organizing in jurisdictions without income taxes. Nevada, for example, does not impose a corporate income tax. Of course, a business formed in Nevada but operated remotely from somewhere else may still be subject to income tax liability according to the laws of the state from which the business actually is operated. Moreover, the business will need to pay minimum taxes (the annual minimum franchise tax in California or Delaware, for example) in both the state of its incorporation and the state from which the business is operated.

By organizing an online division as a separate legal entity, in a state without or with relatively low tax levels, the business may be able to shelter a certain amount of its income from taxation, assuming the proceeds are kept within that jurisdiction and reinvested for growth. Similarly, some US businesses look to offshore jurisdictions for the organization of new ecommerce divisions, to minimize income tax obligations.

What about insurance coverage for online business risks?
Traditional business insurance such as commercial general liability insurance or errors and omissions insurance may not cover many of the risks associated with running an online business. These risks may include liability for trademark and copyright infringement as a result of the content displayed on a website, liability for defamation or invasion of privacy, and other privacy claims associated with the business’s use, display, or distribution of consumer personal information.

Property policies cover only tangible property and not data, and they tend to focus on the perils that are typically involved in losses to tangible property, such as fire, explosion and wind. Business interruption insurance that is sold as part of such property policies may not cover the loss of electronic revenues due to a distributed denial of service. Standard crime forms safeguard only against losses resulting from fraud related to or the theft of money, securities or other tangible property. Computer fraud and information theft that results in damage or deleted information assets are deemed intangible are likely not covered.

Commercial general liability policies generally do not cover damage to or the loss of the use of property that is deemed intangible property. Moreover, errors and omission insurance policies often exclude coverage for losses arising from breaches of security and/or failures to prevent unauthorized access. A breach of network security can result in claims from customers whose client information was stolen and denial of service claims from customers who could not access a site, as well as claims from anyone to whom a computer virus was transmitted. New specialized insurance products, designed to fill gaps in property, CGL and E&O policies, may be available to insure against these risks.