Starting out on the road to being a consultant is a very exciting time. There is often much on the consultants mind and selecting a business name and legal structure usually isn’t the first thing on ones mind during this monumental step; However, over time it is important to understand the different legal structure options and how they can be used to help separate business and personal assets in order to limit the liability and exposure of the consultant. It is highly recommended that the consultant contact their accountant and business lawyer in order to understand fully which business structure is best for them. This article simply points out some of the different legal structures and should not be taken as gospel.
There are many different legal structures that are available to the consultant. The most relevant are
- Sole Proprietorship
- Limited Liability Company (LLC)
- C Corporation
- Professional Service Corporation (PC)
From the outset, if a consultant uses their own name and doesn’t file any legal structure, by default they will be a Sole Proprietorship. This obviously makes this form of business the easiest to establish and minimizes start-up costs. There is one major disadvantage to this type of legal structure; the owner has unlimited liability for the company. In other words, there is no legal separation between the individual and the business. Legal issues with the business will mingle with personal property, savings and assets.
So how can one limit their legal liability to their business? This brings up one of the most common legal structure used by consultants; Limited Liability Company (LLC). An LLC has the advantage of limiting an owners liability and thereby separating the business and individual legally. Some states may require the creation of an operating agreement in order to obtain the full benefits but commercially off the shelf versions are available. There are many advantages to an LLC including the fact that taxes can still be filed along with personal income taxes. This business structure fits in between a more complex structure of corporations and the simpler Sole Proprietorship. The costs for creation are and maintenance are usually around $25 per year in addition to the extra cost during tax season to file a schedule C. The additional cost is worth hedging the risk!
In certain circumstances, such as the consultant company grows large enough or reaches a certain level of income, it may make sense to change the structure to a “C” corporation. This is the most complex form of business organization is comprised of three different groups of people; shareholders, directors and officers. Corporations are subject to more government regulation and earnings may be subject to double taxation when they are passed through to stockholders. However, corporations are the most common organization of large companies and are unto themselves a completely separate entity from those managing it. Corporations though are expensive to organize and maintain and extensive record keeping must be kept.
The final business structure that is useful to consultants are Professional Service Corporations (PC). These corporations are made up exclusively of licensed professionals. These companies must annually file professional service documents to their state showing their shareholders are all licensed or authorized to provide the professional service. The benefit of this structure is that it gives the professional the benefit of a corporation while not altering the law involving liability of the individual licensed. This is not a commonly used structure but may be of benefit to a licensed consultant.