When starting a consulting business, one of the most important decisions to make is choosing the right legal structure. The most common options are Limited Liability Company (LLC) and S Corporation (S Corp).
Both LLCs and S Corps offer liability protection for business owners and have similar tax benefits. However, there are some key differences between the two structures that can impact a consulting business.
LLCs are a popular choice for small businesses, including consulting firms. They are relatively easy to set up and maintain, and provide personal liability protection for the business owner. LLCs are also flexible in terms of taxation, as they can be taxed as a sole proprietor, partnership, or corporation. This flexibility allows LLCs to choose the tax structure that best fits their business needs.
S Corps, on the other hand, are a type of corporation that can elect to be taxed as a pass-through entity. This means that the business itself does not pay federal income tax; instead, profits and losses are passed through to the shareholders and reported on their personal tax returns. S Corps are popular among consulting businesses because they allow owners to avoid paying self-employment taxes on their share of the business profits.
However, S Corps have more strict requirements than LLCs, including limits on the number and type of shareholders, and more formal record-keeping and reporting requirements.
What is an S Corporation?
An S corporation, also known as a Subchapter S corporation, is a tax status that is available to certain small businesses.
According to the IRS, an S corporation is “a corporation that elects to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes.” This means that the business itself does not pay federal income tax.
Instead, the business income, losses, deductions, and credits are passed through to the shareholders, who report them on their individual tax returns.
To qualify for S corporation status, a business must meet certain requirements. It must be a domestic corporation, have only allowable shareholders (which includes individuals, certain trusts, and estates), and have no more than 100 shareholders. In addition, all shareholders must be U.S. citizens or residents.
One of the main advantages of S corporation status is that it can help small business owners save money on taxes. Because the business itself does not pay federal income tax, the shareholders can avoid the double taxation that can occur with a traditional corporation.
In addition, S corporations can provide limited liability protection to their shareholders, which can help protect their personal assets from business debts and liabilities.
What is an LLC?
An LLC or Limited Liability Company is a flexible business structure that combines the benefits of a partnership and a corporation. It is a popular business structure for small business owners, including consultants, because it provides the owners with personal liability protection without the formalities of a corporation.
One of the main benefits of an LLC is that it separates the owner’s personal assets from the business’s liabilities, which means that the owner’s personal assets are not at risk if the business is sued or goes bankrupt.
This protection is not absolute, and it is important for LLC owners to follow corporate formalities and maintain accurate records to ensure that their personal assets are not at risk.
Another benefit of an LLC is that it is a pass-through entity for tax purposes, which means that the business’s profits and losses are passed through to the owners’ personal tax returns.
This avoids the double taxation that occurs with a corporation, where the business’s profits are taxed at the corporate level and again when they are distributed to the shareholders as dividends.
LLCs are also flexible in terms of management and ownership. They can be managed by the owners themselves, or they can appoint a manager to handle the day-to-day operations of the business. They can have a single owner or multiple owners, and the owners can be individuals, other businesses, or even foreign entities.
Pros and Cons of an S Corp for a Consulting Business
Pros
An S Corporation is a popular choice for small businesses, including consulting businesses. One of the primary benefits of an S Corp is that it allows for pass-through taxation. This means that the business itself does not pay taxes on its profits. Instead, the profits and losses are passed through to the shareholders, who report them on their personal tax returns. This can result in significant tax savings for the business and its shareholders.
Another advantage of an S Corp is that it offers limited liability protection to its shareholders. This means that the personal assets of the shareholders are generally protected from the debts and liabilities of the business. This can be especially important for consulting businesses, which may face potential legal liabilities from clients or other parties.
Finally, an S Corp can offer greater flexibility in terms of ownership and management than other types of corporations. For example, an S Corp can have up to 100 shareholders, and these shareholders can be individuals, trusts, or other entities. Additionally, an S Corp can have a board of directors and officers, or it can be managed by its shareholders.
Cons
One potential downside of an S Corp for a consulting business is that it can be more complex and costly to set up and maintain than other business structures, such as a sole proprietorship or a partnership. For example, an S Corp must file articles of incorporation with the state, adopt bylaws, hold regular shareholder meetings, and maintain detailed corporate records.
Another potential drawback of an S Corp is that it may not be the best option for businesses that are looking to raise significant amounts of capital.
Unlike a C Corporation, an S Corp cannot issue multiple classes of stock or have more than 100 shareholders. This can limit the ability of the business to attract investors or raise funds through the sale of stock.
Finally, an S Corp may not be the best choice for businesses that are looking to retain earnings for future growth or expansion. Because an S Corp must distribute its profits to shareholders each year, it may not be able to reinvest these earnings in the business.
Pros and Cons of an LLC for a Consulting Business
Pros
An LLC, or limited liability company, is a popular business structure for consulting businesses. One of the main advantages of an LLC is that it offers personal asset protection. This means that the owner’s personal assets are protected from the company’s debts and legal liabilities. In other words, if the company is sued, the owner’s personal assets, such as their home or car, are not at risk.
Another advantage of an LLC is that it offers flexibility in terms of management and taxation. LLCs can be managed by the owners themselves or by a designated manager. Additionally, LLCs offer pass-through taxation, which means that the business itself does not pay taxes. Instead, the profits and losses are passed through to the owners, who report them on their personal tax returns.
LLCs are also relatively easy and inexpensive to set up and maintain. They require less paperwork and formalities than corporations, and they do not have as many ongoing compliance requirements. This makes them a popular choice for small businesses and startups.
Cons
While LLCs offer many advantages, they also have some drawbacks. One of the main disadvantages of an LLC is that it can be more difficult to raise capital than with a corporation. LLCs cannot issue stock, which makes it harder to attract investors.
Additionally, LLCs may not be as well-known or respected as corporations, which can make it harder to establish credibility with potential clients or partners.
Another potential disadvantage of an LLC is that it may not be the best choice for businesses that are looking to grow quickly or expand into new markets. LLCs may have limitations on the number of owners they can have, and they may not be able to offer the same incentives or benefits to employees as corporations.
Finally, LLCs may not be the best choice for businesses that are subject to high levels of regulation or government oversight. Depending on the industry and location, corporations may be subject to more stringent regulatory requirements than LLCs.
Factors to Consider When Choosing Between an S Corp or LLC for a Consulting Business
Tax Implications
One of the most important factors to consider when deciding between an S Corp or LLC for a consulting business is the tax implications.
Both LLCs and S Corps offer pass-through taxation, meaning that the business itself is not taxed, but rather the profits and losses are passed through to the owners and reported on their personal tax returns.
However, S Corps have some additional tax advantages over LLCs. S Corps can provide their owners with a reasonable salary and then distribute the remaining profits as dividends, which are not subject to self-employment taxes. This can result in significant tax savings for S Corp owners.
On the other hand, LLCs offer more flexibility in terms of taxation. LLC owners can choose to be taxed as a sole proprietorship, partnership, S Corp, or even a C Corp, depending on their specific needs and circumstances.
Ownership Structure
The ownership structure is another important consideration when choosing between an S Corp or LLC for a consulting business.
S Corps have strict ownership requirements, including a limit of 100 shareholders and only one class of stock. This can make it difficult for S Corps to raise capital or bring on new investors.
LLCs, on the other hand, have much more flexible ownership structures. LLCs can have an unlimited number of owners, and the ownership can be divided into membership interests, which can be customized to meet the needs of the business.
Liability Protection
Both S Corps and LLCs offer liability protection for their owners. This legal protection means that the owners’ personal assets are generally protected from the business’s debts and liabilities.
However, LLCs offer more robust liability protection than S Corps. LLC owners are not personally liable for the company’s debts or liabilities, and their personal assets are generally protected.
S Corps, on the other hand, offer limited liability protection, and shareholders can be held personally liable for the company’s debts and liabilities in certain circumstances.
Setting up An LLC
See here for our general instructions on setting up an LLC. Click here if you want a guide on establishing an LLC in your state. And finally, see our recommendations for the best services to form an LLC, which we’ve also included in the table below.
| Image | Product | Features | Price |
|---|---|---|---|
Best value  | Form an LLC with Incfile for FREE ($0)
| 9.6 | Get the best deal |
Best customer service  | Northwest Registered Agent LLC Formation Form an LLC online with Northwest for $39
| 9.5 | Get the best deal |
Industry leader  | Form your LLC online with ZenBusiness for $49
| 9.4 | Get the best deal |
Conclusion
Choosing between an LLC and an S Corp for a consulting business can be a difficult decision. Both business structures have their advantages and disadvantages, and the best choice depends on the specific needs and circumstances of the business.
For small consulting businesses with low profits, an LLC may be the most suitable option. It is less expensive to set up and maintain, and it offers flexibility in terms of how the business is managed and taxed. However, if the business is expected to generate significant profits, an S Corp may be a better choice. It offers tax benefits and can help the business owner save money on self-employment taxes.
Regardless of the business structure chosen, it is important to consult with a qualified attorney or accountant to ensure that all legal and tax requirements are met. This will help the business owner avoid costly mistakes and penalties down the road.
Overall, the decision between an LLC and an an S Corp status for a consulting business is an important one that should not be taken lightly. By carefully considering the needs and goals of the business, and seeking professional advice when needed, the business owner can make an informed decision and set their business up for success.
