Get over it: choose a legal entity

One of the first things you need to do when you start your business is to choose a legal entity. But it can be confusing.  S-corp, LLC, sole proprietor, how do you choose?

When I was first thinking about how to start a consulting business, I read a lot about the differences between different business entities. However, all the details and technicalities were overwhelming, and my indecision stopped me from actually doing anything. Another problem I ran into was that I had it stuck in my mind that starting a business was something that other people did–not me. I thought that it was unrealistic as well as complicated to start a business. As a result, I wasted time in “analysis paralysis”:  researching and reading without taking any action.


questions

Image credit Chris Baker.

Then, my wife wisely suggested that I meet with the CPA at the company where she worked, since he had a fair amount of experience with small companies, and also did taxes for small businesses and entrepreneurs. I took him to lunch, outlined what I was thinking about doing, while at the same time inwardly thinking that I’d get laughed at for being unrealistic. But he was great. He validated my consulting business idea, as well as what I’d already read about legal entities, and gave me advice that was invaluable.

So what route did I go? I’ll go into the details in a bit.  But first:

How much does it cost to create a business entity?

Glad you asked!

The cost varies from state to state, and will depend on the legal entity (corporation, LLC, etc.) that you choose. However, don’t get fooled into thinking that you have to pay thousands of dollars to create your legal entity. Technically, I suppose if you had a pile of cash laying around and wanted to do such a thing, you could pay an attorney or company to create the legal entity for you.

But we’re bootstrapping here, doing things on the cheap.

Truth is, you can create a business entity for your consulting business for a small fraction of what an attorney or other online service might charge. You could either research the filing requirements for your state yourself (which is the way I did it), or you could use one of the following reputable legal services providers to walk you through the process:

Does a legal entity protect me from liability?

Sometimes, but it’s always best to also have liability insurance for your business as well. Your business entity–such as a corporation or LLC–can provide protection of your personal (non-business) assets, but your business assets can be protected through liability insurance that you’d purchase for your company. When you become a consultant, make sure you protect yourself.

How do I choose between the different business entities?

This was one of the things I struggled with when I became a consultant. There’s a lot of info available, and it can be tough to figure out which is the best for your situation.

A great article outlining each business entity type, their pros & cons, and situations where each makes the most sense can be found at QuickSprout (it was originally linked from an article on the Inc. Magazine website).

And, of course, you should go take a look at the IRS’s website for their info on business entities.

My choice

In the end, I chose to form an S-corp when I started my consulting business. By the time I talked to my CPA friend, I had already narrowed down my choices to either an LLC or an S-corp. However, the main factor that tipped the scales for me deciding to go the S-corp route was that with an S-corp, I was able to make myself an employee (although I sometimes subcontract to others, I have no plans for hiring employees). As an employee:

  • I can pay myself a salary,
  • reduce the self-employment taxes that I pay compared to being a sole proprietor,
  • can have my corporation contribute to a SEP-IRA retirement account for me,
  • and have my corporation pay 100% of my family’s health insurance premiums (which, for a family of 4 is like a small mortgage payment every month).
  • In addition, the employer-paid social security and Medicare taxes, the SEP-IRA contributions, and the health insurance premiums are all business expenses which lower the net income for the corporation. Why do I care about this? Because the less net income from my consulting business, the less taxes I’ll have to pay.

Things may have changed since I formed my S-corp, and LLC’s may offer those same advantages. In any case, for me, I think that an S-corp has been a good choice.

One last caveat: I’m neither an attorney nor an accountant, so any legal or accounting advice I give is based on my own experience; you should seek the advice of a competent attorney and/or accountant for your situation.

 

7 Responses to Get over it: choose a legal entity

  1. I latterly registered LLC service company, It’s a little Home-based business, I am the sole proprietor of this home-based little business enterprise. This LLC company does not have even one employee, I am living in a Rented apartment, Since I am coursing this small line of work in my flat in which I am remaining by paying monthly rent. Can I claim my flat monthly snag as disbursements of my Home-based small LLC company while filing Taxes Quarterly?

    • Thanks for your comment!

      If I understand correctly, it sounds like you want to use your apartment’s rent as a business expense. First, I’m not an accountant, so I’d advise getting advice from a qualified CPA. However, my understanding is that you won’t be able to expense your entire rent, but might be able to expense a portion of your rent if you have an office or room in your apartment that you use EXCLUSIVELY for your business. From what I’ve heard, write-offs for home offices are often a red flag for audits though, so you’ll need to be especially careful and get appropriate professional advice for your situation.

  2. That is exactly how i feel regarding it.

  3. Matt says:

    Greg – I left a comment/question on another thread of yours before I saw this. I think this helps me. Thanks.

    • Thanks for your comment! Generally, and LLC is typically less administration, but both LLC’s and s-corp’s can be fairly equivalent for most people. However, it’s always a good idea to check with your accountant to discuss your specific situation.

  4. Guy says:

    Hello,
    Great little article you wrote. It helped a lot on insight and better understanding on my decision for which business entity to choose. What is your opinion about forming an LLC and then selecting to be taxed as an S Corporation? I see this as having the best of both worlds. You selected to operate as an S Corporation only. May I enquire as to why you chose the path you took and not the one I had specified?

    • Good question, but I’d advise asking an accountant about the tax question for your specific situation. When I made my decision, I had talked to a CPA acquaintance who had a lot of experience doing taxes for small businesses, so I made my decision based on the info & advice that person gave me.

      In my experience, paying for accounting advice is money well spent, since it gives great peace of mind.

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