When you’re just starting to make a go at independent consulting and are providing outside services to a client, the question of establishing the right business entity comes up. Sole Proprietorship, Partnership, Corporation, LLC. What are the differences, and which one is right for you? Here we break it down and let you know what each of them provides.
Why You Should Care
Companies are often concerned that a consultant will be viewed as their employee. This is considered “misclassification.” To protect themselves from this risk, companies often have checklists for consultants to demonstrate that they are truly their own business.
What You Can Do to Lower Misclassification Risk
- Use your own supplies and equipment to conduct your work
- Maintain control of when, where, and how you do your work
- Invoice for your services; don’t just send accounting of hours worked (e.g., don’t fill out a timecard)
- Work on a fixed cost basis; demonstrate that you are taking on risk as a business owner (you may end up not making your desired hourly rate)
- Demonstrate that you invest in your business (e.g., getting business insurance) and market yourself (e.g., advertise)
The clearest way EM Marketing consultants distinguish their own businesses is by establishing a separate business entity like a corporation or an LLC, but we’ll go through each of the different options.
Establishing a sole proprietorship is easy — you automatically are one! You can use your name and social security number, and you just start. The risk for you as an individual though, is that you have full personal liability for anything that happens to your business. Some companies may be hesitant to do business with you because the misclassification risk is considered high. On top of that, it can also be difficult to get investors or loans from banks.
A partnership is similar to a sole proprietorship, but with shared liability and responsibilities with two or more partners. According to Rocket Lawyer:
- “Partnerships can be very similar to Sole Proprietorships in the sense that the business is not necessarily an independent entity; in the simplest form of Partnership, all partners contribute capital and all are fully liable for business debts. Each partner will pay taxes separately, although information about income and expenses is filed for the Partnership as a whole. The Partnership Agreement is merely a way to share Sole Proprietorship. However, other variants of Partnerships may differ in how liability or capital contributions are structured.”
Corporations are the most difficult to set up and maintain. You can use the services of a company like LegalZoom to set you up, or just go through the Secretary of State to set it up yourself. You will pay separate state and federal taxes for your corporation but can use an S-Corp tax structure to pass through income or losses to your personal returns and not pay federal taxes at the corporate level. (What is an S-corp?) You may want to establish a corporation if you want to grow or in order to have shareholders.
An LLC is a hybrid legal structure which provides the limited liability features of a corporation with the operational flexibility and tax reporting status of a partnership/sole prop. In regards to taxes, an LLC is treated as a “pass through,” so you report taxes on your individual income tax return. The benefits of this compared to a corporation are that there are fewer costs associated with establishing an LLC, as well as minimal recordkeeping.
Easy Ways to Demonstrate Your Business Is Really A Business
In addition to choosing the right business entity, it’s also important to prove that you are investing in it and advertising the business’ services its own entity. Here are some quick and easy tips that we recommend to our consultants for their businesses:
- Invoice for your services: If you can show that you have multiple clients that have paid you, it’s easier to establish that you truly own a business. Make sure to keep records of your invoices and payments.
- Business cards and letterhead: VistaPrint has free business cards and inexpensive stationary.
- Business email: You can probably get YournameConsulting@gmail.com for free from Google.
- Business phone number: Google Voice is free; Skype phone numbers are $5 a month paid annually.
- Fictitious business name: Register with the county clerk; sole prop with surname does not need to officially file a fictitious business name.
- Federal Tax ID number: It takes 5 minutes.
- Separate bank account.
- Create a website. Wix, Squarespace, and Weebly are a few examples of free sites where you can build and host.