Best Business Structure for Consultants

As a professional consultant, you spend plenty of time determining how other businesses work. But how much time have you put into determining the shape of your own business? Choosing the best legal entity for your enterprise will help minimize your risks and maximize your profits. That way, you can concentrate on consulting.

What's best for your business? That depends. The type of legal entity you choose can affect how hefty your pile of paperwork and administrative duties are, the amount you pay in taxes, and how exposed you are to personal liability in the event of a lawsuit. You don't want damages that coming out of your own pocket, either in the form of cash or seized assets.

The Most Common Legal Business Structures for Consultants.

There are four primary types of business structure you'll want to consider for your consulting business. Here is a breakdown of what makes each unique:

Sole Proprietorship

If you are the only person involved in your consulting business and if your business is not incorporated, you are probably already a sole proprietorship. This is usually the case if you're freelancing or acting as an independent contractor. What's great about a sole proprietorship is that, typically, very little paperwork is required. You don't have to register as a sole proprietor with your state. You may, however, need to file a DBA certificate if you're operating your business under a name different than your own. DBA stands for "Doing Business As".

Depending on where you operate, you may require DBAs to obtain certain licenses and permits.

In the eyes of the law, sole proprietorships are considered to be "pass-through" entities. This means that both your business and personal assets and liabilities are considered one in the same. As a result, you don't have to file a separate tax return for your business; the profits and losses of that business simply pass through directly into your tax return. When tax time comes around, you just report the business income and expenses on your individual Form. Easy enough. But, keep in mind you will be responsible for withholding necessary income taxes like self-employment taxes, which pay for Medicare and Social Security.

The biggest knock on operating as a sole proprietorship is that it exposes your personal assets to risk. For instance, if a client blames your consulting for financial losses and sues for negligence, your personal assets, including your bank account and house, could be up for grabs if they win. That's a risk you need to make certain you're prepared to take.

Limited Liability Company

It may surprise you to learn that Limited Liability Companies (LLCs) are not incorporated businesses. Instead, they're unincorporated structures that involve one or more owners.

Like a sole proprietorship, all of the LLC's profit and losses pass through to the owners' individual tax returns. Personal income and self-employment tax also need to be withheld by each owner. There is also more paperwork involved. Authority requires you to file the Articles of Organization (there is a fee). And, it's considered good form to draft an operating agreement for your LLC. This agreement lays out what is expected of each LLC owner.

So, why form an LLC? Unlike sole proprietorships, LLCs offer better asset protection, including shielding owners from personal liability. This can happen if your business gets sued for negligence, caught up in illegal activity, or in the event, one of your co-owners is found responsible for personal wrongdoing. The only way your personal assets are at risk is if the operation of the LLC and it is determined that there is little difference between the owner's assets and those of the business. In that event, personal assets can be taken. To avoid this, it is important you distinguish yourself from your business, starting with keeping separate bank accounts.

A good rule of thumb is to form an LLC only if there is more than one owner. That's because a single-owner LLC is generally treated as a "disregarded entity", where business and personal assets and liabilities are not considered to be separate from each other, and so much more.