Running an eBay business may have developed by accident. You started by selling a few things, only to find that you could make money this way. Your sales volume has grown and now you want to know if it's time to take legal steps to formalize your business.

Your Choices
You can incorporate your business - a process you do under state law. This automatically makes you a regular, or "C," corporation - an entity that is a separate taxpayer. Or, once you've incorporated, you can elect S corporation status by filing forms with the IRS and your state, if applicable, so that profits, losses and other tax items flow through the corporation to you and are reported on your personal tax return. Instead of incorporating you can form a limited liability company (LLC) under state law. Like any corporation, LLC status gives you personal liability protection; creditors can only look to the assets of the business to satisfy their claims. And like an S corporation, income and losses of the business are taxed on your personal tax return.

Factors in Making a Choice
There's no income threshold or other financial event that tells you if or when to formalize your business through incorporation or LLC status. Whether you continue as a sole proprietorship or become an S corporation or LLC, you'll pay federal income tax on all of the business's profits.

Will formalizing your business improve your eBay sales? Some customers may prefer to deal with corporations or LLCs, perceiving them as a more permanent presence than individuals so there will be someone to go to with a problem. But because the assurance of reliability on eBay is based primarily on feedback scores rather than on company titles, this is probably not an important factor in reaching your decision. Other factors include:

• Personal liability protection. Creditors can't touch your personal assets if you incorporate or form an LLC; only your business bank account, inventory and other business items are at risk.
  
• Taking on partners. As your eBay business grows, you may wish to share the load with someone else. A partner can complement the skills you bring to the business and can also provide new capital to buy inventory and expand your operations. A formal business organization, such as an S corporation or LLC, makes it easy to bring in new blood to the business.
  
• Hobby loss protection. If your business experiences losses year after year (your expenses exceed your profit from sales), formalizing your business can help to overcome IRS charges that you're conducting a hobby so that your losses are not deductible. However, this formality is not a guarantee that the IRS won't argue you are conducting a hobby activity.
  
• Employment taxes. If you are a corporation, you only pay Social Security and Medicare (FICA) taxes on wages. In contrast, sole proprietors and LLC members pay Social Security and Medicare (self-employment tax) on all business profits, whether or not distributed.
  
• Audit risk. Statistics show that the IRS examines more returns of sole proprietors than those of corporations and LLCs.
  

Note: Formalizing your business organization can be pricey. There are initial formation costs that can run several hundred dollars or more in state charges and attorney's fees. And there are ongoing costs for maintaining a separate entity, including costs for new business checks, stationery, etc. as well as for preparing and filing tax returns.