Disclaimer: Please note this article is not financial advice. The purpose of our blog is purely educational, so please consult a professional accountant or financial advisor before making any financial decision.
You need to study so many things first if you plan to start a business, even if you do it on Amazon FBA. During your research, you must find the best-selling items, your potential suppliers, your target market, and how much capital you'll need, just to name a few. One essential aspect that must be considered is the type of business you'll choose.
An informed decision is vital to your success and longevity. Dive deeper into this article and find out the smartest form of business to consider to save more and lower your Amazon tax rate.
The Different Forms of Business
There are four types of businesses: sole proprietorship, partnership, corporation, and limited liability company (LLC). The most common are the first two, sole proprietorship and partnership. They are easy to start up and don't require much paperwork.
Their biggest downside is that the owner is personally liable for any debts or liabilities the business may incur in the long run. On the other hand, corporations are complex to build but offer significant advantages. The owners are not liable for any debts or liabilities the business may have and they can enjoy limited liability.
The LLC has the advantages of the three forms. It's relatively easy to set up and owners are not liable for any debts or liabilities.
How These Businesses Are Taxed
Again, each type of business has its advantages. However, the way they are taxed plays a significant role in decision-making.
Sole Proprietorship
The owner pays taxes on their personal income tax return. The business itself is not taxed separately. It can be disadvantageous because the owner's tax rate may be higher than the corporate tax rate.
Partnership
Each member pays taxes on their share of the partnership income on their personal income tax return. The partnership itself is not taxed separately. This can be disadvantageous because the partners' tax rates may be higher than the corporate tax rate.
Corporation
The corporate tax rate is usually lower than the individual tax. It's an advantage if the business is earning. Many businesses are set up as corporations so business owners can reap the benefits of having lower taxes.
Limited Liability Company (LLC)
In terms of liability, LLC combines limited liability protection within a tax structure, while owners or shareholders enjoy limited personal liability for business related debts. When it comes to taxation, LLCs can choose between being taxed as a corporation or as a partnership.
Sole Proprietorship or Corporation: Which One Is Good for Your Business?
As mentioned, it is essential that you make an informed decision based on your financial standing and your financial goals in the upcoming years. It's not required to create a corporation when you sell on Amazon. However, you need to understand the different taxation situations that come with each type of business.
If you build your business as a sole proprietorship, you're going to pay a tax rate for Amazon based on the revenue you generate from your Amazon business. Aside from Amazon, there's a chance you have other sources of income. What you earn from Amazon and your other sources will be added to your personal income tax rate, potentially placing you in a higher tax bracket.
In case you declare your business as a corporation, the money you make from Amazon is not going to be added to your personal income. It will then be accounted for using a corporate tax rate. It means that you can enjoy a lower tax bracket both on personal income or corporate tax bracket.
The Example You Need
To better understand how the tax works between a corporation and a sole proprietorship, here's a good example for your convenience.
Assume that you are a resident of Ontario and you make $50,000 from your full-time job, another $10,000 from other sources, and $60,000 revenue from Amazon in a year at a 30% profit margin for a total of $20,000 profit at the end of the year. That would place you at the bracket for $80,000 in personal income after all deductions.
If your Amazon business was declared as a sole proprietorship and you have an annual personal income of $80,000, you need to pay about 38% in tax between federal and provincial tax, which will fall at around $19,782.
However, if you set up your business as a corporation, you will pay a corporate income tax rate on your $20,000 profit, and a personal income tax on $60,000. You will have to pay $14,580 on your personal income tax. Then for your corporate tax, you will have to pay $2,840 for a total of $17,420.
Just So You Know…
| You might be wondering how the corporate tax was computed. Here’s what you should know. Say you earn $20,000 from Amazon as a corporation. You need to pay 38% as per Basic Part I Tax, which is $7,600. Then deduct the Small Business Deduction which is 17% and the Federal Tax Abatement of 10%. The total deduction is $5,400. One last addition is the provincial tax. Assuming that you are from Ontario, that would be 3.2%, equivalent to $640. Your total corporate tax owing is $2,840. Simplified Formula: Corporate Tax = Taxable Income ✕ 38% − (Taxable Income (17% + 10%)) + Provincial Tax |
In this particular scenario, it's strategic and beneficial to have a corporation set up rather than a sole proprietorship, as you will be paying less overall.
To understand more about Canada's tax system, read Amazon Taxes: Diving Into the Canadian Tax Landscape, written by one of our CPAs in Unloop.
When You Sell On Amazon
Depending on your goals, you can always revisit your resources and business projections to see what is more beneficial for you. Reassess your personal situation, then make a decision.
If you are a Canadian, you don't have to be an American LLC to sell on Amazon. If you are happy to set up your Amazon business as a corporation, all you have to do is register federally or in your province.
You can also save more if you will open a cross-border banking account to receive US dollars. Remember that most transactions on Amazon are in US dollars. Amazon usually remits money or your earnings in accordance with your country. If you do business in Canada, you'll receive it in Canadian dollars.
In order to transact with Amazon, you have to convert those Canadian dollars to US dollars and the conversion has a fee depending on the amount you convert. To prevent losing money to conversion rates, opening a cross-border banking account is necessary.
Final Thoughts
Setting your business as a corporation is very strategic, especially when we talk about how much tax on Amazon you'll be subjected to. Having an informed decision will lead to your business success and longevity. When you open a business on Amazon and you operate in Canada, don't forget to open a cross-border account that will save you more and prevent excess conversion fees.
Still worried about your accounting? Unloop is here to guide you. We are experts in multi-channel ecommerce, and have numerous happy clients in our portfolio. Get in touch with us; we’d love to talk to you!