Business Advice for Contractors
Tuesday, April 21st, 2009 Subscribe To Our Feed
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At some point in every small contracting business, a decision has to be made on how to structure the business for growth. Contractors seldom going into business with the goal of staying small. Research into the tax and legal considerations should be thoroughly considered.
Taking a Contractor Business for Small to Large
Business structure has a lot to do with why some businesses grow and others don’t.
There are three types of legal business entities that should be considered:
1. Sole Proprietorship
2. Limited Liability Corporation (LLC)
3. S Corporation
Which of these you choose depends on what fits the best with your existing business. This is a discussion that should occur between you and a qualified attorney. We can only tell you how you shold think about the process.
As any good lawyer will tell you there will be certain trade-offs made on each of the three options. Set-up costs, liability and investments are some of the areas that should be discussed. We will go into a summary of these trade-offs later in this article. The decision ultimately boils down to a few main considerations, including set-up, liability, investments. There will be certain trade-offs made depending on which way you go. For extensive information on taxes and filing for different business structure, go to the IRS website at http://www.irs.gov/businesses/small. If you’re business is at the point where structuring decisions have to made, you should be looking into retaining the services of a lawyer, who can best explain the liability issues faced with each business structure, particularly as the pertain to your state. In short: starting a business? Get a lawyer.
Sole Proprietorship
From a set-up standpoint, establishing as a sole proprietor is the easiest way to go. As the sole proprietor of your contracting business, you own all the assets and profits generated by the business. This also means you assume all the debt and liability. In a sole proprietorship you and the business are one and the same! This is an extremely important detail, as it means were the business to get sued for any reason, both the business and your personal assets are at risk. Think about the nature of your business and the services you provide. What are the chances of being sued? This question isn’t meant to frighten, but it is a serious consideration to make.
In terms of tax preparation, the sole proprietorship is the easiest. Contractors will be required to file using the individual 1040, Schedule C (or C-EZ) and Schedule SE for self-employment tax. The full list of forms needed can be found through the IRS link above.
Partnership
It is understandable why some contractors would want to go into a partnership. Sharing the work-load, decision-making, and other responsibilities can make the task of getting a business off the ground seem much more bearable. Partnerships require good planning and discussionsd should occur as who is the primary decision maker,and which partners has responsibility for different areas of the business. A beer and a handshake shouldn’t cut it. Decisions on the business structure should not be taken lightly because the law views partnerships the same as sole proprietorships - with lno difference between the business and its owners. Before establishing as a partnership, take the time to write up an agreement.
There is more than one type of partnership, too. There are general partnerships, limited partnerships, and joint ventures. Most contractors will find that joint ventures don’t apply as they are intended for one-off situations. In a limited partnership one or more of the partners assumes limited liability and limited input and decision-making ability. These are common in situations when attracting investors, and might not suit the contractor business scenario.
When filing as a partnership, Schedule K-1 (Form 1065) may have to be filed, as well as any employment tax forms. The 1040, self-employment, and estimated tax forms for individual returns are a requirement of partnerships. Partners are not employees and therefore are not issued W-2s from the business. This kind of business structure is considered a “pass-through entity,” which means profits pass through the business directly to the partners.
Corporation
Corporations are entities considered separate from those who own and/or run it. The owners are considered shareholders, and as such assume limited liability. An elected board of directors is a requirement of corporation which must meet on a regular basis to oversee business operations. Set up and maintenance require more work when choosing a corporation and yearly tax preparation can also require more paperwork. Although the advantage of limited liability is important, another plus for establishing a corporation is the easy transfer of ownership through the sale of stock. To incorporate, the business must be granted a charter by the state in which the business is based, and an assortment of expenses incurred for incorporation fees, legal matters, and purchasing of stock certificates can set the business back as much as $1500 or more. Corporations are taxed once when the income is earned and again on the individual tax return.
A subset of the corporation business structure is the S Corporation, or Subchapter S Corporation. Earnings and profits are passed through to owners and their individual tax returns in this structure. In this way the double taxation scenario is avoided. There are certain limitations that come with being an S Corporation, but for some small businesses the easier tax process makes the choice worth it.
Limited Liability Company (LLC)
Although neither a partnership nor a corporation an LLC combines a few features from both of those structures. Business owners who opt for an LLC receive the same liability protection as a corporation but also have a flexible profit distribution typically found in general partnerships. Although there is still more filing to be done, setting up an LLC is still easier than setting up a corporation. Paperwork and fees will apply, and specific state regulation may mandate written operating agreements that determine many of the same guidelines needed in a successful partnership, such as profit distribution, responsibilities, and rules to determine ownership changes.
Personal Experience
Josh Macmichael is the sole proprietor of a successful seamless gutter business based in New Hampshire, called New London Seamless Gutters http://www.nlseamlessgutters.com/title=”nlseamlessgutters”/>nlseamlessgutters. For Macmichael, business structure was a fairly simple decision. “Sole proprietorship is just a heck of a lot easier,” says Macmichael. “It’s easier to set up, easier to deal with payments, and doesn’t cost the money that incorporating costs.” Although he acknowledges that the nature of his contracting work (installing and working with gutter systems) is inherently risky, the conveniences of sole proprietorship far outweigh the risks of assuming full liability should an accident occur on the job site. “From a liability standpoint, sure, I should probably be an LLC, but you can be looking at $3,000 or more to get a lawyer to go to work on all the filing and paperwork. You can see why new businesses would go with a sole proprietorship.”
What Should You Do?
Contractors, like any small business, are often caught between where they are today and where they want to be in five or ten years. There are different levels of bookkeeping and paperwork required for each of the three different structures. Changing the businesses legal structure is possible if the one you choose isn’t the right choice. The government can become easily confused when businesses change their structure so good accounting practices become essential.
Record keeping and liability protection against lawsuits are two of the areas that you should discuss with an attorney.
Another option you might want to check out is the ContractorBlab
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