After becoming a consultant, it is tempting to concentrate on the advantages of being self-employed. In all likelihood, you will not have thought much about the best business structure for consultants. However, it is vital to give some consideration to this, to increase your bottom line and reduce your tax liability. There are four main kinds of structures that the majority of consultants opt for. All have their own distinctive set of benefits and drawbacks:
The Sole Proprietor Model
As a sole proprietor, you are classed as an unincorporated company, or an independent contractor, consultant or freelancer. You don’t have to complete any forms to begin this kind of venture. All you have to do is declare your business expenses and income on Form 1040, under Schedule C. Taking this route is the simplest way to get started in business — and the simplest way to dissolve your business if things go wrong — however, it offers limited safeguards.
The C Corporation Approach
C Corporations are incorporated businesses that enter their tax records on Form 1120. Each type of business, aside from the sole proprietor model, is regarded as an individual entity, which typically offers shareholders a degree of financial and legal protection. Corporation shareholders have restricted liability protection. Also, corporations control how much money they retain or distribute. Most corporations are classed as for-profit organizations, so they could potentially make a loss for many years.
Although this might help you when it comes to filling out your tax return, it is best to speak to your tax adviser like Walker Wayland AMD Chartered Accountants for further details.
The S Corporation Structure
An S Corporation shares similarities with a partnership (which is taxed on Form 1120S). If any shareholders provide services to the company, the S Corporation has to pay those shareholders fair wages. These wages are separate payments from profit or loss distributions. An S Corporation has the same fundamental benefits and drawbacks of a closed or general corporation. An S Corporation avoids being ‘taxed twice’, unlike a C corporation, because all loss or income is only declared once on the shareholder’s tax returns.
Nonetheless, as with regular corporations, and in contrast to certain partnerships, shareholders of S Corporations do have personal liability for any business debts.
The LLC (Limited Liability Partnership) Option
An LLC is an unincorporated business (taxed on Form 1065). In contrast to corporations, these organizations require a General Partner. This individual, or individuals, assume unrestricted liability for the company. Also, partnerships require at least a couple of shareholders and distribute all the profit and loss to these shareholders, with no concern for any money retained by the company to facilitate cash flow. Lots of business people think that LLCs are a better option than partnerships and corporations because they include many of the benefits of each.
Although the above business structures are the main ones that will be relevant to you, other options exist — such as nonprofit organizations and trusts, however, they are not usually utilized by consultants. Just be aware that there are many possibilities for your company, as far as choosing your structure goes. Always pose the right type of questions to yourself, such as: “Is it indispensable to incorporate?” and “How will this benefit me?”.