You’ve worked hard to specialize and sharpen your skills and now you’re ready to branch out and start your own business. There can be many benefits to starting your own consulting business including, but not limited to, control of your work-life balance, ability to earn more money, and power to decide how your brand will be marketed, and what values your business will stand for. However, as you embark on such an exciting journey, there are a couple of upfront issues you definitely need to consider.
Here are a few talking points you should address with your lawyer and CPA as you start to plot out next steps:
(1) Should I Form a Legal Entity?
When considering forming a legal entity there are three primary reasons we see clients benefit from doing so:
(a) Limited Liability Protection
By operating your business through a legal entity (by “through a legal entity” we mean that your clients will sign a contract with your legal entity rather than with you individually), you create a shield wherein which a client would sue your legal entity, and not you personally, if an issue arises. This protects your personal assets including your home, retirement savings, car and other assets. Such a separation can make a huge difference if you have a slip up, and is a key reason many people form a legal entity.
Furthermore, this liability protection doesn’t stop with just clients. It also applies to your team of consultants and employees you might hire to assist with various projects. We recommend you read our post regarding labor and employment issues that come with hiring independent contractors (read more here), but the moral of the story is that like your clients, if a service provider you hire has an issue with your business he/she/it will be suing your legal entity, and not you personally.
(b) Tax Savings
While certainly not a hard and fast rule, some of our clients are able to save money on taxes by establishing a legal entity and then electing to have it taxed as an S-Corporation. One important thing to understand is that an S-Corporation is not a legal entity; it’s a tax election which means whether you form a Limited Liability Company (LLC) or a Corporation, both can elect to be taxed as an “S-Corp”.
As an owner of an entity taxed as an S-Corp, you can set yourself a reasonable salary, and then after you pay out your salary and other business expenses, you can take a profit distribution and the profit distribution will not include withholding for the standard self-employment taxes that a sole proprietor would pay on every dollar earned. Depending on the amount of revenue earned you can see a potential tax benefit under the aforementioned S-Corp structure.
While alone it is not enough of a reason to start an entity, one additional perk our clients enjoy is the ability to create a more professional marketing persona under a legal entity. For example, if I am hiring “Blue Mountain Consulting”, it’s at least ambiguous as to whether or not I’m hiring a solo outfit or a team of fifty employees. Such a persona is more difficult to pull off if you remain a sole proprietor.
(d) Common Downsides to Forming an Entity
Many professionals and skilled service providers got to where they are because they are smart enough to stay in their lane, and when necessary, hire others to assist on matters they otherwise are not equipped to handle. Thus, forming an entity will come with legal and filing fees (roughly $1500-2500 if using our firm depending on your desired setup, and we’re happy to discuss in greater detail your specific situation). Additionally, by forming a legal entity you will now be an entity that owes a minimum franchise tax of $800 every calendar year to the state of California, and that franchise tax can go up from there depending on revenues earned. Finally, especially those consulting businesses that establish S-Corp taxation or have multiple owners, you will need to setup payroll and it is advisable to work with a CPA to handle taxes, which come with additional business expenses.
(2) So I’ve Decided to Form an Entity, What Other Key Decisions Must I Make?
Certain professions are limited as to the type of legal entity they can form. By way of example, attorneys are only permitted to establish “professional corporations” or “limited liability partnerships”. Therefore, depending on the type of work you will perform you will need to analyze if there are any limitations as to the type of entity you can form.
Additionally, you are advised to speak with a CPA to see if they recommend a certain tax structure (including but not limited to a “disregarded entity”, “S-Corp” or the less frequent “C-Corp” structure) based on your forecasted business activities and revenue.
Furthermore, and it’s recommended you do so with the assistance of a lawyer, you need to pick and analyze the name you plan to use for marketing purposes to ensure you will not run into downstream issues with a competitor, or with governmental regulations from the respective governmental body that governs your business activities (by way of example, the State Bar of California places restrictions on certain names that can be used).
Finally, you cannot form a legal entity until you’ve first established where your business will be located and who will serve as your registered agent (you can read more about a registered agent here). Certain cities will not allow the use of mailbox (such as a UPS Box) and California will not allow you to list a PO Box as a corporate business address.
While not an exhaustive list, we’re hopeful you can use this outline to help kick off the conversation internally, and with their team of helpful professionals. We frequently assist clients who are transitioning to their own business, and we’d be happy to setup a time to talk about your specific situation in more detail.
Disclaimer: This post discusses general legal issues and developments, is intended to serve as informational only, and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Archetype Legal PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.