What is the Best Structure for a Consulting Business?

Some consultants prefer to operate an LLC rather than be a sole owner or owner of a corporation because this entity combines many of the advantages of the other two entities. If you run a small operation and want to protect your assets, this is likely the best legal structure for your consulting business. The consulting company model is to run a consulting business with a team instead of doing all the customer-facing work yourself (like a solo consultant). In the eyes of the law, sole proprietorships are considered “transfer entities”.

This means that both your business and personal assets and liabilities are considered to be you. As a result, you don't have to file a separate tax return for your company; that company's profits and losses are simply transferred directly to your tax return. When it's time to pay taxes, simply declare the company's income and expenses on your individual Form 1040, Schedule C. However, keep in mind that you will be responsible for withholding necessary income taxes, such as self-employment taxes, which cover Medicare and Social Security expenses.

The biggest drawback of operating as a sole proprietorship is that it exposes your personal assets to risk. For example, if a client blames your consultant for financial losses and lawsuits for negligence, your personal assets, including your bank account and home, could be at stake if you win. It's a risk you should make sure you're prepared to take. Like a sole proprietorship, all profits and losses from the LLC are transferred to the owners' individual tax returns. Every landlord must also withhold personal income tax and self-employment.

There's also more paperwork involved. The Secretary of State requires you to submit the Statutes (there is a fee). And it's considered a good way to draft an operating agreement for your LLC. This agreement sets out what is expected of each owner of an LLC. So why create an LLC? Unlike sole proprietorships, LLCs offer better asset protection, even protecting owners from personal liability.

This can happen if your company is sued for negligence, if it is involved in illegal activity, or if one of its co-owners is found responsible for a personal crime. The only way your personal assets are at risk is if the LLC operation “cuts through the corporate veil” and it is determined that there is little difference between the owner's assets and those of the company. In that case, personal property may be confiscated. To avoid this, it's important to distinguish yourself from your business, starting with maintaining separate bank accounts. To create an S Corporation, the Secretary of State requires that new companies submit articles of incorporation and pay the filing fee.

A board of directors must also be appointed. As with a sole proprietorship, S Corporation profits and losses go to shareholders' personal tax returns, where they will be taxed at the individual rate rather than the corporate rate. S corporations can also pay dividends to shareholders. The benefit here is that those dividends are not subject to self-employment tax, resulting in substantial savings for the corporation.

However, if a shareholder provides a service to Corporation S, the corporation must pay the shareholder a salary, which is subject to tax. Another benefit that S corporations have is that they avoid double taxation of C corporations. As with an S Corporation, the Secretary of State requires you to submit articles of incorporation and, at the same time, elect a board of directors that will assign business activities to officers. Your C Corporation will have to pay appropriate taxes on all profits. In addition to that, all employees of Corporation C will also have to pay taxes on their earned income.

Since taxes occur here on two levels, what is known as double taxation is created. However, your C Corporation won't have to pay corporate taxes if you end up recording losses during the year. This can happen for unlimited years due to the fact that C corporations are generally presumed to be for-profit companies. Showing a loss can generate savings benefits when paying taxes. However, this is something you should discuss with an accountant or tax advisor for guidance specific to your situation.

Even if you are the sole shareholder of your C Corporation, meaning you own a 100% stake, you are exempt from personal liability for business debts and a lawsuit, as long as you don't pierce the corporate veil. Consultants often prefer LLCs because they offer flexibility in small operations while protecting their assets from risk. However, forming and maintaining an LLC requires paperwork and fees; if you'd rather not deal with that then a sole proprietorship could do it before you. S corporations are usually better suited for large consulting firms with several shareholders and employees; it provides protection for assets like an LLC but imposes more liability on shareholders.

Unless your consulting business is about to become big then a C Corporation is most likely not right for you; they can be unnecessarily large and complex and don't offer many advantages beyond what you can get with an LLC or S corporation. You can be the sole owner or have partners; as with a sole proprietorship taxes are handled on Schedule C of your personal tax return; your personal assets are protected from creditors or in the event of a lawsuit.

Ernest Oesterling
Ernest Oesterling

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