How to Decide What Type of Legal Entity is Best for Your Consulting Business?

Your business will need to choose 1) a legal structure and 2) a tax classification. These are two separate topics but they often get blurred together. A business owner consults with an attorney to discuss entity law and an accountant to discuss tax consequences. It can easily sound like everyone is using the same words but with different meanings. Don’t worry, we are here to help you understand this with confidence.

An accountant helps you decide the tax classification of your business.

An accountant should help you choose a tax classification. You have 5 options which are sole proprietor, partnership, S corp, C corp, or trust. Notice that “LLC” is not a tax classification. In our experience, most creative businesses start out as sole proprietors and shift to an S corp when their income level gets to a certain point when it would save money on their taxes.

When you talk with an accountant, be ready to discuss anticipated income. The accountant will want to know things like how much in sales you expect to earn and what states (or even cities) you will be earning the sales in. Why does that matter? Taxes are governed at federal, state and local levels. For example, if your sales are mainly earned in New York City, the cost of the S corp tax classification is significantly higher than if your sales are earned outside of the city. How can that be? New York City adds an additional tax on S corps. The tax rate depends on income level. The rates that we see for most of our clients are 6.5% – 8.85%.

What are the basic facts about tax classifications?

• A single-owner LLC must elect tax classification of sole proprietorship or S corp or C corp.
• A multi-owner LLC must elect tax classification of partnership or S corp or C corp.
• A corporation will be taxed as a C corp unless they specifically file a form to the IRS electing S corp classification.

An attorney helps you decide the legal structure of your business.

An attorney should help you choose a legal structure. You will most likely have 4 options which are sole proprietor, partnership, limited liability company (LLC ) or corporation (corp). Notice that “S corp” is not a legal structure. In our experience, most creative businesses start out as sole proprietors and shift to an LLC or corp when their risks increase or they want to shift their ownership structure.

When you talk with an attorney, be ready to discuss who your owners and investors will be. The attorney will want to know things like how many owners and investors there will be, who they are, where they live, and how they will expect to share in the profits. They will also want to know how the owners and investors will be involved in the daily operations of the business.

What are the basic facts about LLC vs corp legal structures?

• Both an LLC and a corp will protect the owner’s personal assets.
• LLC owners are called members. Corp owners are called shareholders.
• LLC’s and corps can have an unlimited number of owners. Except, if the corp elects S corp tax classification, they will be limited to < 100 owners.
• LLC’s and corps can have foreign owners. Except, if the corp elects S corp tax classification, they can only have owners that are US citizens or resident aliens.
• LLC’s and corps can have owners that are corps or partnerships. Except, if the corp elects S corp tax classification, the owners must be individuals only.
• LLC’s cannot provide stocks to their owners. Corps must provide stocks to their owners and those stocks steer how profits are paid out.
• A corporation’s tax classification determines the stock they can provide to owners. An S corp can only offer one class of stock which means they only have one way to divide profits to owners. A C corp can offer various classes of stock which means they have more options for how to divide profits to owners.

Choosing the right legal entity and tax classification is key to your consulting business’s growth and stability. The distinctions between legal structures and tax classifications are complex but critical. At Colvin CPA, we simplify this vital process, guiding you confidently from start-up to scale-up.

Eager to position your consulting business for success with expert guidance? Connect with us. We offer the tailored advice you need for informed strategic decisions. Start your journey to effective business planning with Colvin CPA today. Contact Us