Owning your business means responsibility for everything, from the little details like choosing your CRM and what brand of coffee to buy for the office to major decisions like deciding to go into business debt vs. using cash to grow your business.
Some business decisions, like what brand of highlighters to use, don’t ultimately affect the big picture. (Unless you’re a highlighter snob, in which case you are perfectly aware that brand-name highlighters can dance neon circles around their inferior Bic counterparts.)
But other decisions, like your business structure, can significantly impact your bottom line. This is a big deal when you’re a coach or consultant running a one-person show.
This month, we’re answering the question: Do I need an LLC for consulting work?
Let’s dive in.
LLC vs. Other Business Structures
Selecting your business structure is one of the most crucial parts of starting a business.
This is important because your business structure affects how much you pay in taxes, what kind of paperwork you must file, and your personal liability.
Here are the most common business structures with an explanation of how they are taxed and what kind of liability protection they offer:
A sole proprietorship is a business owned and operated by only one person. Legally, there is no separation between the owner and the business entity, which means the owner can be held personally liable for the debts and obligations of the business. The business owner reports all income and expenses on their personal tax return. Business profits are subject to self-employment taxes, including Social Security and Medicare.
Tldr: One owner. Pays self-employment taxes. No liability protection.
A partnership is owned by two or more individuals. Each partner is legally and financially responsible for the partnership. Decision-making is also shared between members. The partnership files an information return to report income and expenses, but the individual partners report their share of the partnership’s profits and losses on personal tax returns. Partnerships are subject to self-employment taxes.
Tldr: Two or more owners. Pay self-employment taxes. No liability protection.
A corporation means the owner is responsible for the business but is a separate legal entity from the company. A corporation can be composed of a single member or many. The owner or owners are not legally responsible for the debts or lawsuits against the business. The corporation pays income tax on the corporation’s income, and you pay tax on your salary.
Tldr: One or more owners. Pays your portion of taxes through the business. Liability protection.
An LLC protects the owner from being personally liable for debts or liabilities. If your business is sued, your personal assets will be protected. Depending on how an LLC is taxed, it can be treated as a partnership, a sole proprietorship, or a corporation for tax purposes. The member or members report all profits and losses on their individual tax returns.
Tldr: One or more owners. Taxes depend on your business structure. Liability protection.
What is the difference between an LLC and a Sole Proprietorship?
Most of my consulting clients at Tax Savvy Jessica are solopreneurs, so that’s what I’ll focus on here.
You might wonder if you should choose an LLC or a Sole Proprietorship for your business.
If you’re doing business as yourself in an unofficial capacity (i.e., you’re consulting and doing business as Sara Smith with no official business filing), the state will consider you a sole proprietor. You and your business are essentially the same legal entity for legal and tax purposes.
This presents a liability problem.
Imagine Sara Smith is working as a health and nutrition consultant. One of her clients has diabetes and experiences a health episode while following Sara’s protocol. If the client sues Sara, her personal assets, like her home, car, and bank accounts, would be at risk without LLC protection.
Consultants Should Consider Liability Issues When Working With Clients
As a consultant, Sara’s income is derived from the information and advice she provides to clients. In a perfect world, all clients would be reasonable, and all consultants would be great at what they do.
But we don’t live in that world.
Sometimes consultants make mistakes or even behave negligently. Sometimes clients want to seek legal action, which may or may not be justified.
The reality is that consultants must consider liability when choosing a business structure.
Forming an LLC Offers Legal Protection
When you form an LLC for your business, you create a separate entity from yourself. Without an LLC, Sara Smith is simply doing business as Sara. But with an LLC, she becomes a business owner with a legal entity entirely separate from herself.
Forming an LLC separates her business assets from her personal assets. If she is sued, her personal assets will be protected.
Other Benefits of An LLC
- Flexibility: LLCs are taxed as pass-through entities by default, but LLCs can be taxed as a corporation if it’s more advantageous for the business.
- Avoiding Double Taxation: Unlike corporations, LLCs are not taxed as separate entities. Profits and losses are passed through to your personal tax return, meaning you won’t pay taxes on your business and your income.
- Tax Deductions: An LLC allows you to write off your business expenses, lowering your overall tax burden.
- Credibility and Professionalism: Forming an LLC makes your business look more professional. This can be especially helpful when you’re starting out and are working to attract clients.
An LLC Is a Smart Choice for Consultants
While you don’t require an LLC to do consulting work, forming one offers numerous tax and liability advantages. Setting up an LLC is easy and inexpensive to do. It protects your personal assets and improves your professional image. Overall, it’s a great business move for coaches and consultants.
Need Business Structure Advice?
Tax Savvy Jessica offers business consulting and personalized tax strategy plans to six-figure coaches and consultants tired of paying too much in taxes.