When you first make the choice to become self-employed, there are a number of resulting decisions to work thorough. Some choices are easy and others are more complicated, but navigating these decisions is an excellent proving ground for how ready you are to become an independent.
One of the most important questions you’ll consider is how to structure your business. One such avenue is an LLC.
Do I need an LLC for Consulting Work?
What is an LLC?
An LLC is a business structure that provides a middle ground between operating a corporation and a sole proprietorship: it allows for the pass-through taxation of a sole proprietorship while also providing the limited liability of a corporation.
Because an LLC is not considered to be a separate entity, the company itself is not taxed and does not take on losses. Instead, all company profits and losses are reported on the personal income tax returns of LLC owners. At the same time, these owners are protected from personal liability, just like corporations.
These two main features can make LLCs a good business structure option for independent professionals. Here are four advantages to becoming an LLC.
Pass-Through Taxation
Pass-through taxation is most commonly found in sole-ownership scenarios where generated income flows directly to the owner. This means that income is treated as the direct income of the LLC owner, with taxation “passing through” to their individual tax returns.
With an LLC, you do not incur corporate taxes as you do with other business structures, so you avoid the double taxation trap. Instead, LLC owners must report their share of profit and losses on their individual tax returns.
While LLCs owners are subject to paying self-employment tax—the Social Security and Medicare tax that would normally be paid by the employer and employee—on their personal income tax return, they can deduct half of self-employment taxes as a sole proprietor would.
Some states, such as New York, California, and Texas, may also charge extra franchise tax on LLCs, and most states have a higher state-filing fee on this entity format.
Best State to Form an LLC for Consulting
If you have been researching corporations or LLCs, you’ve surely heard that forming your entity in states like Wyoming, New Mexico, and Colorado can offer you various benefits above and beyond what your state can offer you. While it may be true that these states do have some benefits which I’ll discuss below, you have to consider whether or not those benefits even apply to you.
Whenever a corporation or LLC transacts business in a particular state, it must register with that state. This means that it has to pay taxes in that state and file reports, just as if it was actually formed there, so if you are operating a “local” business that caters to customers that mainly live in the state you reside in, it generally would not make sense for you to form your corporation or LLC in a different state only to then need to register in your home state anyway. While there are exceptions, in most cases, you might as well just form your entity in the state in which you live and keep things easy on yourself! Why have the extra fees, taxes and paperwork? It makes no sense!
Tip! – A good way to determine whether or not you are “transacting business” in your home state is if you lease office space or have employees there. If either of these are the case, then you will most likely be required to register to transact business in your state and it will be much easier if you just form your corporation or LLC there in the first place.
If you do not have a brick and mortar business, such as an internet-based company or a consulting business, then you may have some more options open to you. Since Corporations and LLCs are entities entirely separate from you – they are like separate people – which means that they can live wherever they choose, which may or may not be the same state that you live in. Some states have more favorable tax laws or better corporate infrastructures. If you have spoken to your attorney and have determined that your business is in fact not transacting business in your state, then you have a decision to make!
S Corp or LLC for Consulting Business
LLCs are unincorporated businesses (taxed as a 1065 business). Owners, legally referred to as members, of an LLC are shielded from personal liability for any failings of the business. Similar to a sole proprietorship, profits and losses are reported directly on owners’ individual tax returns.
When you become a consultant, you may focus only on the benefits of working for yourself without giving much thought to your consulting business’ structure. However, it’s important to consider your options to maximize your profits and minimize the taxes you owe. Most consultants choose from four key types of business structure, each with its own unique set of strengths and weaknesses:
Sole Proprietor
A sole proprietor is an unincorporated business. Sole proprietors are usually referred to as independent contractors, consultants, or freelancers. You don’t fill out any forms to start this type of business. The only thing you need to do is report your business income and expenses on your individual Form 1040, Schedule C, when filing your taxes. This is by far the easiest form of business to set up—and the easiest to dissolve—but it provides the least protection.
If there is an expectation that the work you do could lead to a lawsuit, being a sole proprietor might not be the best option. As a consultant, for example, you may be asked to offer advice to clients. If a client suffers financial losses from the advice you gave that the client argues is negligent, your personal assets could be at risk.
Limited Liability Company (LLC)
LLCs are unincorporated businesses (taxed as a 1065 business). Owners, legally referred to as members, of an LLC are shielded from personal liability for any failings of the business. The only exception would be if it was proven that an owner or owners were acting illegally. Similar to a sole proprietorship, profits and losses are reported directly on owners’ individual tax returns.
Many business professionals believe LLCs present a superior alternative to corporations and sole proprietorships because LLCs combine many of the advantages of both. If you have a small consulting business and want to be sure your personal assets are protected, this likely is the best option.
S Corporation
If an S corporation shareholder provides services to a 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 the business debt.
An S corporation structure is likely only an option if your consulting business is relatively large, with several shareholders and multiple employees. Protections are similar to those of an LLC, but shareholders must elect a board of directors and maintain detailed records. S corporations are limited to no more than 75 shareholders.
Should I Set Up an LLC for Consulting
The primary benefit of an LLC over a sole proprietorship is that it shields you from personal liability for the obligations of the entity. This is may not be a benefit to most casual consultants. Liability for professional malpractice in most states is usually personal, even if performed through an entity.
Part-Time Consulting: Do You Need an LLC?
You have decided to get away from the numbers, and follow your bliss by going to the Culinary Institute of America to become a pastry chef, but want to do some consulting on the side to finance your transition and pay for your toque and full set of balloon whisks. Or you may do some consulting to accommodate family demands, or as an adjunct to an existing job. If this is your situation, do you need to set up an entity through which to conduct your practice?
If you have a small part-time consulting practice, you may think you need to set up a corporation or limited liability company. This article will discuss some of the factors you should consider in deciding whether you should do so. Anyone who spends more than five to ten hours a week consulting, or who has a partner, should take the plunge and set up an entity. You can consult the articles in the last three issues to learn about some of the issues you need to consider if you do so. But what if you have a client or two? What are the benefits and drawbacks of setting up a business entity?
Should I form an LLC for Consulting Work
As an independent consultant, you’ve likely thought about taking your business to the next level. Whether you’re operating as an individual, part of an informal network, or co-leading a boutique firm, creating a more formal business entity can bring substantial benefits to your practice and help you establish a strong presence with Catalant clients.
I went through the diligence process a couple of years ago and decided to form a limited liability company (“LLC”). An LLC has advantages and disadvantages depending on your unique situation but was the ideal entity for my business. While you should of course consult with a professional who specializes in business incorporation and can provide guidance for your specific situation, below are a few considerations I took into account when deciding to form an LLC.
Can an LLC be an independent contractor?
An independent contractor is someone who is working for someone else and who provides services, but who is not an employee. … An independent contractor can be any type of business entity (sole proprietor, corporation, LLC, partnership), but most independent contractors are sole proprietors.
The terms “sole proprietor” and “independent contractor” are both used to discuss small business owners, usually one-person businesses. So, are they the same thing? What’s the difference?
I’ll give you the short, simple answer and a bit more explanation to clarify:
Here’s the short answer: The terms “sole proprietor” and “independent contractor” are both used to describe single-person businesses, but they are used in different contexts. You can be both a sole proprietor and an independent contractor. You can be a sole proprietor as a taxpayer, paying your taxes on Schedule C, along with your personal income taxes.
At the same time, you can be an independent contractor as it relates to working for someone else and receiving a 1099-MISC to show your earnings, instead of a W-2 (received by employees). Your 1099-MISC income is included in your Schedule C, along with other business income you receive.
They are essentially the same: both are self-employed. The big difference is in how they are considered for certain taxes. The sole proprietor is a type of business for income tax purposes, and an independent contractor is the opposite of an employee, for payroll tax purposes.
Do I need an LLC to be self employed?
But if you are self-employed, you must pay all of your Social Security and Medicare taxes yourself. If you are a sole proprietor, a partner in a general partnership, or a member of an LLC that is taxed as a disregarded entity, you will pay self-employed tax.
Being self-employed has its perks: you don’t have to go to an office, answer to a boss or wear a suit every day. But self-employment does have a major downside: you have to pay self-employment tax.
New business owners, freelancers and consultants are often shocked at how much of their income is eaten up by the self-employment tax. Depending on your situation, you may be able to reduce self-employment taxes by forming a corporation or a limited liability company.
What Is the Self-Employment Tax?
If you are someone else’s employee, your employer pays half of your Social Security and Medicare taxes, and the other half is taken out of your paycheck. But if you are self-employed, you must pay all of your Social Security and Medicare taxes yourself. This is what is known as the self-employment tax.
For 2014, the Social Security tax is 12.4 percent of your income, and the Medicare tax is 2.9 percent of your income. You pay Social Security tax only until your income reaches $117,000; there is no Social Security tax on the portion of your income that is greater than that. You pay Medicare tax on all your income, and there is an additional .9 percent Medicare tax on wages that exceed $200,000.
If you are a sole proprietor, a partner in a general partnership, or a member of an LLC that is taxed as a disregarded entity, you will pay self-employed tax. You must calculate self-employment tax and income tax and make quarterly estimated tax payments to the Internal Revenue Service, or you could be subject to fines and penalties. An online self-employed tax calculator can help you estimate your taxes.
Do I need LLC for 1099?
However, if the LLC is taxed as a partnership or is a single-member LLC (disregarded entity), the contractor needs to receive a 1099 form and you need to file a 1099 for this contractor. The simple rule of thumb is: if the LLC files as a corporation, then no 1099 is required.
What are the benefits of incorporating yourself?
Incorporation has many benefits for small business owners, and here are five reasons why consultants should consider incorporating:
- Limited Personal Liability
- Potential Tax Savings
- Reduced Chances of Tax Audit
- More Affordable Health Insurance
- Increased Credibility
