The Best Business Structures for Consultants
Define Your Structure to Maximize Profits and Minimize Your Tax Burden
When you become a consultant, you may only focus on the benefits of working yourself. You likely have not given much thought to your consulting business' structure. But it's important to give this some thought in order to maximize your profits and minimize the taxes you owe. There are four key types of business structures that most consultants choose from. Each has its own unique set of strengths and weaknesses:
A sole proprietor is an unincorporated business and is usually referred to as independent contractors, consultants, or freelancers. There are no forms you need to fill out to start this type of business. The only thing you need to do is report your business income and expenses on your Form 1040, Schedule C. This is by far the easiest form of business to set up — and the easiest to dissolve — but it provides the least protection.
A C Corporation is an incorporated business (taxed as 1120). Every form of business, besides the sole proprietor form, is considered a separate entity, and this often provides a measure of legal and financial protection for the shareholders. The shareholders of corporations have limited liability protection, and corporations have full discretion over the amount of profits they can distribute or retain. Corporations are usually presumed to be for-profit entities, and as such, they can have an unlimited number of years with losses.
This can be a benefit at tax time but talk with your accountant or tax adviser for more information.
S Corporations have features similar to a partnership (taxed as 1120S). If any shareholder provides services to the business, the S-Corporation must pay that shareholder a reasonable salary.
This salary is a separate payment from distributions of profits or losses. S Corporations have the same basic advantages and disadvantages of general or closed corporations. S Corporations avoid the “double taxation” of C corporations because all income or loss is reported only once on the personal tax returns of the shareholders. However, like standard corporations, and unlike some partnerships, the S Corporation shareholders are exempt from personal liability for business debt.
Limited Liability Partnership or “LLC”
LLCs are unincorporated businesses (taxed as 1065). Unlike corporations, partnerships must have at least one General Partner who assumes unlimited liability for the business. Partnerships must also have at least two shareholders. Partnerships distribute all profits and losses to their shareholders without regard for any profits retained by the business for cash flow purposes. Many business professionals believe LLCs present a superior alternative to corporations and partnerships because LLCs combine many of the advantages of both.
The Bottom Line
While these four are the main types of business structures that will apply to you, there are also options like trusts and non-profit structures, but they are not typically used by consultants.
Just know that you have an array of options for your business when it comes to picking your structure. Make sure to ask yourself the right kind of questions, like “Do I need to incorporate?” and “Why would I want to?”
Legally, you don’t even need to incorporate, and maybe that smaller degree of maintenance would suit your business well. On the opposite side of that coin, maybe things like liability, tax savings, and raising capital are on the forefront of your mind, in which case incorporating may suit your business very well. Picking your business structure is important and is really all about what works best for you.