As a professional consultant, you spend a lot of time figuring out how other companies operate. But how much thought have you given to the form of your own company? Choosing the proper legal entity for your business will help you reduce risks while increasing earnings.
But what is the best option for your company? That is debatable. The legal entity you pick can have an impact on how much paperwork and administrative obligations you have, how much tax you pay, and what level of professional indemnity insurance you will need.
Consultants’ Most Common Legal Business Structures
There are basically four different types of company structures for your consulting firm. Here’s a rundown of what makes each one distinct:
A sole proprietorship
A sole proprietorship is a business entity that is owned and operated by one person.
You’re probably already a sole proprietor if you’re the only individual participating in your consulting firm and it’s not incorporated. If you’re freelancing or working as an independent contractor, you are essentially a sole proprietor.
The benefit of a sole proprietorship is that it usually requires relatively minimal paperwork. Your state does not require you to register as a single owner. If you’re conducting your business under a name other than your own, you may need to file a DBA (Doing Business As) certificate.
Your state may need DBAs to get various licenses and permissions, depending on where you operate.
Sole proprietorships are considered “pass-through” businesses from the perspective of the law. This implies that your personal and corporate assets and obligations are treated as one and the same. As a result, you won’t need to submit a separate tax return for your business; its earnings and losses will simply be included on your personal tax return. You just record the business revenue and costs on your own Form 1040, Schedule C, when tax time arrives. However, bear in mind that you will be liable for withholding required income taxes, such as self-employment taxes, which fund Medicare and Social Security.
The most significant disadvantage of running a single proprietorship is that it puts your personal assets at risk. If a customer holds you responsible for financial losses and sues you for carelessness, your personal assets, such as your bank account and home, might be at risk if they win. That’s a risk you should be sure you’re ready to take. One way of mitigating this risk is to have professional indemnity insurance in place.
Limited Liability Corporation (LLC)
Limited Liability Companies (LLCs) are not incorporated enterprises, which may surprise you. They’re unincorporated structures with one or more owners.
All of the LLC’s profits and losses are passed through to the owners’ individual tax returns, just like a sole proprietorship. Each owner must additionally withhold personal income and self-employment taxes. There’s also extra paperwork to deal with. You must file the Articles of Organization with the Secretary of State (there is a fee). In addition, drafting an operating agreement for your LLC is considered an excellent form. This agreement specifies what each LLC owner is responsible for.
So, what’s the point of forming an LLC? LLCs, as opposed to sole proprietorships, provide stronger asset protection, including protection from personal responsibility. This can occur if your company is sued for carelessness, if it is involved in criminal conduct, or if one of your co-owners is found guilty of personal wrongdoing.
Only if the LLC’s operations “penetrate the corporate veil” and it is judged that there is little difference between the owner’s assets and those of the firm are your personal assets in danger. Personal assets may be seized in that case. To avoid this, it’s critical that you separate yourself from your company, starting with different bank accounts.
If there is more than one owner, it’s a solid rule of thumb to create an LLC. This is because a single-owner LLC is sometimes referred to as a “disregarded entity,” meaning that its business and personal assets and liabilities are not considered distinct.
An S Corporation is a type of incorporated business structure in which owners are given stock shares and, therefore, become shareholders. Your S corporation might have up to one hundred stockholders. This is an excellent structure for consulting firms since it protects your personal assets as long as your business and personal assets are kept separate.
The Secretary of State mandates that new firms file articles of incorporation and pay a filing fee in order to become an S Corporation. It is also necessary to appoint a board of directors.
The income and losses of an S company, like those of a sole proprietorship, flow through to the shareholders’ personal tax returns, where they are taxed at the individual rate rather than the corporate rate. Dividends can also be paid to shareholders via S Corporations. The advantage is that such dividends are not subject to self-employment tax, saving the firm a lot of money. If a shareholder performs a service for the S Corporation, the corporation is required to pay the shareholder a taxable salary.
Another advantage of S Corporations is that they are not subject to the double taxes that C Corporations are.
If your primary worry is that you will not be held personally accountable for the acts of your company, a C Corporation may be the right choice for you. These are generally enormous corporations with a high number of employees and stockholders. C Corporations, like S Corporations, are obliged to distribute stock to their owners in order to nominate them as shareholders.
The Secretary of State requires you to submit articles of incorporation, as well as elect a board of directors who will delegate business activities to the officers, much like an S Corporation.
All revenues earned by your C Corporation must be taxed appropriately. Additionally, all workers of the C Corporation will be compelled to pay taxes on their earnings. Due to the fact that taxes are collected on two levels, this is referred to as double taxation.
Your C Corporation, on the other hand, will not be required to pay corporation taxes if it has a loss for the year. Because C Corporations are believed to be for-profit businesses, this can happen for an indefinite period of time. Having a loss on your books might result in tax savings. However, for precise advice tailored to your case, you should see an accountant or tax consultant.
Even if you possess a 100 percent stock in your C Corporation, you are immune from personal accountability for business debts and lawsuits if you do not break the corporate veil.
Which Structure Is Most Appropriate for You?
The first step in deciding on a structure for your consulting firm is to evaluate if you want or need to incorporate it. It isn’t necessary. It may, however, provide benefits. And those benefits may outweigh the paperwork and upkeep that incorporating entails. After that, think about what each form of entity has to offer. Is it simple to make them? What are the tax consequences? In the case of a legal issue, how much risk are you willing to take?