Is an LLC Essential for Dropshipping? What You Need to Know in 2025

There’s a reason dropshipping has become one of the most popular business models for ecommerce in recent years. Ease of setup, low overhead, not having to deal with physical inventory—it’s a flexible business model for retailers who are testing ideas in the market or looking for a relatively quick path to operability.

But at the end of the day, dropshipping is a business like any other. And setting one up, even if simpler than an inventory-based retail operation, still merits thinking over the same basic questions: What form will the business take? Will you run it as a sole proprietorship, limited liability company (LLC), or something else?

What is an LLC?

An LLC (limited liability company) is a popular business structure in the United States that combines the tax flexibility and reduced paperwork of partnerships or sole proprietorships with the personal liability protection of corporations. As long as owners keep the business’s finances separate from their personal finances, this hybrid entity can shield their personal assets—like a home, car, or savings account—from business debtors and legal claimants.

Owners of an LLC (known as “members”) also avoid double taxation on business income faced by corporations, thanks to the entity’s pass-through taxation status. Unlike a corporation, where profit is taxed first at the corporate level and again when distributed to shareholders, LLC profits are passed through to members and taxed only once at members’ personal income tax rates.

LLCs can be single-member (owned and operated by one person) or multi-member. They can also be a series LLC, wherein a single LLC owns multiple independent divisions (known as “series”). They can be member-managed (run by the owners) or manager-managed (run by someone hired by the owners).

Entrepreneurs often choose the LLC for a dropshipping store because it offers significant legal protection alongside relatively simple formation and maintenance requirements. These benefits are aligned with many of the reasons entrepreneurs get into dropshipping to begin with: ease of setup, flexibility, and some reduced risk.

Benefits of creating an LLC for your dropshipping business

• Limited liability protection
• Tax benefits
• Credibility

The LLC is a very common choice of business structure for dropshippers. The advantages of forming an LLC for a dropshipping business are are several, but some of the key reasons to use the entity type are as follows:

Limited liability protection

The main selling point of an LLC is its liability protection. Under a sole proprietorship, a dropshipper would have personal responsibility for any debts or legal claims against the enterprise.

For example, let’s say a dropshipping business unknowingly sources a toy from overseas that infringes on the intellectual property of a cartoon production company in the United States. As the distributor of the toy in the US, the dropshipping business might potentially be named in a copyright lawsuit against the toy manufacturer. If the business is a sole proprietorship or general partnership, the owners would be personally liable for the damages, and their personal assets might be reachable by the copyright plaintiff if they’re successful in their case. But if the business is incorporated into an LLC, the plaintiff will usually only be able to recover damages from the business’s assets.

There are exceptions. If the LLC owners commingle personal and business finances, they could lose the liability shield. If they sign a personal guarantee for business financing, that may give creditors the ability to hold them personally responsible for repaying the debt. Additionally, they could also be held personally accountable in a lawsuit if there’s evidence of fraud or negligence causing harm to those involved.

Tax benefits

LLCs are treated as pass-through entities for purposes of taxation. Unlike a corporation, where profits are taxed twice (once at the corporate level, and again when distributed to shareholders), an LLC’s profits are taxed one time at the members’ individual personal income tax rates. LLCs can also provide enhanced deduction opportunities compared with sole proprietorships. The formal separation between business and personal money makes it easier to document legitimate business expenses and demonstrate their clear business purpose for tax breaks.

Another benefit of the LLC’s tax treatment is the option to elect to be taxed as an S corporation. An LLC that elects S corp status maintains liability protection while potentially reducing self-employment tax by allowing a member to receive both a reasonable salary (subject to payroll tax) and distributions (not subject to self-employment tax). This can reduce members’ overall tax burden.

Credibility

LLCs generally enjoy more business credibility than sole proprietorships due to their formal legal structure, which can signal to vendors and financial institutions that the business operates professionally. Banks might be more willing to extend business lines of credit or small business loans to LLCs than to sole proprietors, too—which can be crucial to getting a dropshipping business off the ground.

Do you need an LLC for dropshipping?

While LLCs are a common choice for dropshippers, setting one up does entail additional work and expenses. Starting and running an LLC involves costs like formation fees, which can range from $40 to $500, depending on your state. There are fees for annual reports, potential registered agent expenses, and other administrative costs, such as tax preparation (for members who choose to have a tax professional handle their business tax returns).

Operating as a sole proprietorship requires less paperwork—almost none, beyond a personal income tax return and a local business license, if needed.

When considering if the benefits of forming an LLC outweigh the costs, consider the following aspects of your dropshipping business:

• What kind of risk is associated with selling the items you intend to sell? Non-consumable, non-mechanical items like phone cases, digital products, or basic apparel items could present fewer safety and compliance risks than, for example, complex electronics or children’s products.

• What kind of insurance policies can your business get (and afford)? Determine if general liability and product liability coverage offer enough protection for your operation.

How to create an LLC

1. Choose a name for your LLC
2. Appoint a registered agent
3. Obtain an EIN
4. Draft an LLC operating agreement
5. Open a business bank account
6. File articles of organization
7. Obtain necessary business licenses or permits

The process for starting an LLC will differ slightly depending on the state in which you’re setting up shop. But generally speaking, there are seven basic steps:

1. Choose a name for your LLC

Before selecting a name for your LLC, you’ll want to run a check through your state’s business database to ensure the name is available. Most state business agencies don’t allow more than one LLC to share the same name within the state, and typically require you to include “LLC” or “Limited Liability Company” in the name. Some words may also be off limits (like “bank” or “university”).

2. Appoint a registered agent

In every state, all business entities other than a sole proprietorship need to appoint a registered agent—a real person to receive legal documents on the business’s behalf. You can act as your own registered agent, choose an LLC member to do it, or use third-party registered agent services.

3. Obtain an EIN

Before you file formation paperwork with the state, you’ll want to obtain an employer identification number (EIN) for your LLC. This is basically a Social Security number for your business, and allows state and federal tax agencies to track your tax obligations. All 50 states require an EIN to set up an LLC, and it is often needed when opening a business bank account. You can get one for free from the US Internal Revenue Service (IRS) online or by mailing in a completed form SS-4. 

4. Draft an LLC operating agreement

If your dropshipping LLC is operating as a multi-member LLC, create a written operating agreement that outlines, at a minimum:

• Day-to-day business operations

• Duties and rights of various members

• How to handle asset distribution if a member leaves or the LLC shuts down

5. Open a business bank account

One of the reasons to have an operating agreement on hand is many banks require it for you to open a business bank account or apply for financing. For an LLC bank account or loan, you’ll also need a copy of your formation documents and an EIN.

6. File articles of organization

Articles of organization are the LLC formation documents—they’re what the state keeps on file to record your LLC’s existence and compliance with formation rules. You’ll need to file them with the state Secretary of State’s office to officially set up the business. Most states offer online filing options and provide template forms. You can handle this yourself, or hire a specialized business formations attorney to do it for you. The filing fee for articles of organization can range from $40 to $500, depending on your state.

7. Obtain necessary business licenses or permits

Depending on the types of products you’re dropshipping, or your business location, you may need to obtain local, state, or federal business licenses, or professional permits.