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Should a consultant incorporate (and how)?

by apl (Monsignor)
on Jan 09, 2009 at 15:26 UTC ( #735220=perlquestion: print w/ replies, xml ) Need Help??
apl has asked for the wisdom of the Perl Monks concerning the following question:

Due to circumstances beyond my control (Curse you, Bear Stearns!) for the first time in my career I'm looking for work as an independent consultant.

Are those of you who are self-employed (in the U.S.) self-incorporated? If so,

  • what type of corporation did you form?
  • Is it really as easy as the NJ Department of Labor makes it seem, or did you hire a lawyer to do your incorporation?
  • Do you pay yourself a (small) salary and take the bulk of your pay as a corporate dividend?
  • What (beside the obvious -- separate checking account in the name of the corporation, post office box for the corporation, separate room in your home as an office) did you do to establish yourself formally?
  • Can you actually deduct the cost of commuting, lunch, buying relevant books or software, as corporate expenses?
  • Did you need an accountant to file your corporate taxes?

I don't plan on getting more than one or two gigs a year if that, but neither do I want to get audited.

TIA for sharing how to take this first, scarey step.

Comment on Should a consultant incorporate (and how)?
Re: Should a consultant incorporate (and how)?
by eighty-one (Friar) on Jan 09, 2009 at 16:23 UTC

    I'm not a consultant, but I have looked into it, and do have a few friends and family members who have formed corporations.

    If I were going to do any work for pay for someone else, outside of an employee/employer relationship, I would definitely want a corporation to protect me from liability. Any tax or other benefits would just be gravy.

    Most of my friends and relatives have formed S Corporations. I've also see the term LLC, but S-Corp seems to be the overwhelmingly popular choice from what I've seen.

    As for salary, my father (a consultant after dissolving his software company) always paid himself a small salary, had the corporation pay for everything that could be validly considered a 'perk' or legitimate expense, and got the rest of the money he made through the corp . . . Through some other means; sorry I can't give you more info or details there

    Everyone I know has a lawyer and an accountant to keep them straight with Johnny Law. It's expensive, but an hour of a lawyer's time costs less than hiring one for a tax fraud trial. I think the states and the IRS are lenient and good about payment plans and such if you're a small business owner or consultant who, without malice, made a legitimate mistake, but I'd still want a professional to make sure I did everything by the book.

    Everyone I know has an accountant, but they do more than one or two gigs per year. I'm nor sure if it would be easier for a DIY tax preparer to do their own taxes if they only did a few jobs per year. But I would want the accountant to make sure you understood all the laws and regulations. Heck, I have a very simple tax situation and I still get confused sometimes when I try to itemize.

    EDIT: The SBA might be of help, as well. See if these pages help:

Re: Should a consultant incorporate (and how)?
by zentara (Archbishop) on Jan 09, 2009 at 16:28 UTC
    This should be a tutorial. I remember looking into it once, and conceded it was easier to just pay Self-Employment tax. I guess a good place to start would be the one they advertise on tv... LegalZoom

    I'm not really a human, but I play one on earth Remember How Lucky You Are

      Nolo gets recommended by the local consumer affairs reporter / radio show (Clark Howard) as another good source for do-it-yourself / do-as-much-as-you-can-yourself legal info. They've got a pretty good web site plus they publish dead tree guides that go into more detail and have sample forms (my wife used their landlord guide getting things set up renting our old house out).

      The cake is a lie.
      The cake is a lie.
      The cake is a lie.

Re: Should a consultant incorporate (and how)?
by sundialsvc4 (Abbot) on Jan 09, 2009 at 16:46 UTC

    Welcome aboard, the water's fine. I've been doing this for seventeen years and counting, and I would never go back.

    The tax-laws of the United States have many favorable provisions for small businesses, both proprietorships and professional corporations, such as the one you are about to run. The most important distinction is that you are being paid pre-tax dollars, and from this you get to pay all of your expenses ... including office space, automobile time, health insurance (do not neglect this!), liability insurance, business taxes and so forth. The business pays taxes. And, the business pays you.

    The business should pay you a salary, that is to say, on a regular and periodic basis. If there's money in the company's pocket but not yours, and a new flat-screen TV set is jumping off the wall at you ... well, you're just going to have to wait until you get your next paycheck. Hard to do, but you'll thank me for that advice someday. Sometimes the company won't have the money to pay you... but when it has more-than-enough, “remember Joseph in the land of Egypt.”

    Either the S-Corporation or the LLC corporation seems to be the most common ... and since I just received a package today from “Amazon.com LLC,” I'd say that LLC's are today's winner.

    First, you need an attorney. Then, you need an accountant... a CPA, who is also your statutory agent if you need one. Both of these are usually “small businessmen” too; I found both through the church that I then attended. Use them even to do things that you think you know how to do yourself. There are many unfamiliar waters, and just as you are a professional in certain things, they are too. I don't fix my own car, either. These expenses are, of course, business expenses that the business pays.

    When you have a business entity that is correctly formed, and that has a qualified legal representative and a qualified financial representative, and that carries the right kind of insurance and so-on, then that speaks volumes for credibility. It says, “this really is ‘a company,’ not an unemployed hack.” And having said that, let me be very quick to say that I did not just unkindly “slam” you! No... amateurish hacks are out there, and in large numbers. Lots of businesses have been badly burned by them. Image is everything, since instinct and gut-feeling drives a lot of business decisions.

    Hold everything about “the company” at arm's length from everything about “you.” You work for the company, which has exactly one employee right now. There is a sharp and distinct bright-line between the two of them, and that line is never crossed. When and if Mister Auditor comes around, you can open all your books with confidence.

      I think that separation is one of the hidden benefits of incorporation over sole proprietorships: It absolutely forces you to think of the business and your personal finances independently. A lot of trouble can occur when that line gets blurred.

      As to the CPA question: you don't just need one, you want one. S/he will be offering you a lot more than bean counting. You get the advice you need to take advantage of the tax advantages of your configuration in a legal way, and its also an experienced set of eyes looking over your expenses and numbers. A good CPA is one of those expenses you really feel you get your value out of.
Re: Should a consultant incorporate (and how)?
by mr_mischief (Monsignor) on Jan 09, 2009 at 16:46 UTC
    I am currently a sole proprietor. This opens me to many forms of liability a corporate employee or shareholder normally is not theoretically. However, unless you have what a court would call a valid corporation, you can still be held personally liable from what I understand. IANAL, and I don't play one on TV or the Internet, so this isn't legal advice.

    As I understand my own jurisdiction at a minimum you must have a board (who can be friends and family), you must have so many periodic meetings (with frequency determined by jurisdiction) with formal minutes, you must be able to produce fairly recent bookkeeping upon demand at any point, you must have a registered agent in the state in which you incorporate (which can be, but doesn't need to be, you if you incorporate in the same state in which you live and otherwise you can hire a company that does this for you for not very much). I know people who own small corporations whose board meeting is dinner with 5 minutes of new business and 5 minutes of old business between the main course and dessert, with someone keeping notes. The minutes are an official record and must be kept, but they can be transcribed from a spiral notebook into something more formal.

    I do know people who have incorporated without the help of an attorney. One consultation with an accountant to see about tax rules and another with an attorney about everything else shouldn't be that expensive, though. There are forms you can buy and books you can read for doing it yourself.

    One thing you always want as a business owner, whether a corporation, a limited liability company, or a proprietorship, is business liability insurance. There is something the insurance industry calls a "business key policy" which covers many different types of liability under one package for not very much in premiums. Ask your agent about that. This covers things like slip-and-fall at your location, loss of your computers to fire, etc. It's a nice security blanket, and some office complexes won't even rent space to a business without some minimum coverage. My minimum coverage for my office is $1,000,000 but it's not that expensive to get the policy.

    Another type of insurance to consider is called an "errors and omissions" policy, which protects you in a suit over bugs in your code or failure to implement exactly to spec or other professional errors. That's quite a bit pricier and most of the small business owners I know cover liabilities like that in contracts alone. Your best bet, of course, is to do good enough work not to get sued. ;-) All my customers sign contracts stating who is liable or not for what parts of a project. I refuse to be liable for being provided a poor spec, for not being provided the customer's content or spec on time, for extra time required by changes in the spec, etc. My customer's losses for bugs or downtime are limited to being refunded the cost of the project. A good contract lawyer can draw something like that up to fit in a page or two, at least for my state. Mine is combined with the order acknowledgment and often I staple the customer's paper specs right to that when they provide a paper spec. They sign once to finalize the order, agree to pay, and agree to the terms. The biggest hassle has not been getting it written, but getting everyone to sign it and keeping it filed.

    I currently have an office outside the home, and that's nice for the foot traffic I get. OTOH, being interrupted by foot traffic during programming can be a pain. I'm lucky to be in a historic building with utilities included for a very reasonable rent. If I wasn't here, I'd be in one of the small business incubator buildings in town. If I wasn't so lucky, I'd probably be based from home myself.

    Look into an IP phone service. I have another small business owner with whom I do many joint projects. We also refer many people back and forth. We're probably getting a system together so we can conference and transfer calls back and forth between our different physical locations. It's going to be less than I pay for two voice lines with voicemail as it is. With just one person, you might even be able to use Vonage or such. Having a system that lets you take a business call on your main published line from a different location is nice. You might also consider using a cell phone, possibly with a separate phone number for the business. Adding a line with its own voicemail to your existing plan is probably cheap, but if you incorporate you might want a separate plan. You might be able to have the corporation reimburse you for just the one phone and number on a multi-phone plan, but you may not. You might want to check that part with the lawyer and accountant if you do talk to them.

    My sister-in-law is a CPA specializing in SMB and local government accounting, so I'd use her even if I didn't need an accountant. Since I'm a 1099 recipient instead of a corporation, I'm not sure I'd trust myself to file the taxes. I still would prefer not to do my own books or taxes even if I had a corporation. I'm also lucky to be friends with a number of lawyers, including one of the owners of the assets I bought to start this business. Nearly all my legal documents for the business were written by the contract lawyer who was a partner in the company that previously owned the customer list and leased the office space I use. I wouldn't assume anything, but if you have close friends or family members in these two fields you might catch a real break.

    This isn't legal advice and may be different in your state anyway, but I do know people who are able to deduct commuting expenses to client sites, books, laptops, and even meals while on the road. They have cleared these deduction decisions with their attorneys and accountants, though. I always have someone look over my stuff, too, but as I said I have connections in those fields.

Re: Should a consultant incorporate (and how)?
by sundialsvc4 (Abbot) on Jan 09, 2009 at 16:51 UTC

    A gentleman named Herman Holtz has made a good living writing books about consulting contracts ... and you should read every single one of them. Right Now.

    (FYI:   I have a book that lists his name also as Hermann Holz.)

Re: Should a consultant incorporate (and how)?
by tilly (Archbishop) on Jan 09, 2009 at 18:41 UTC
    How timely. I was just having this conversation today with multiple people, including my accountant.

    For me the decision is easier than for you because I have a contracting opportunity with a company that has an internal rule that they only deal with companies. So if I want the money, I need to make a company. Of course there is still the question of what kind of company I need to make.

    http://www.powerhomebiz.com/vol136/structure.htm has a reasonable overview of the differences between an LLC and an S-corporation. A very superficial explanation is that with an S-corporation there is more up front cost, and more paperwork, but you can save money on things like self-employment taxes. (However be warned that if you pay yourself too small a salary the IRS can decide you're cheating and revise your division of salary/dividend for you.) You can create either fairly easily through a service like legalzoom.

    However if you have created a company, a number of steps are highly recommended. Get yourself an accounting system of some sort. Any sort. A spreadsheet may be sufficient, something like Quickbooks is better. And start a filing system. If ever you are asked by a potential client or the IRS to review your books, you should have your paperwork in order to be reviewed. This means make a copy of all invoices you send. Keep a record of how much money you made.

    A strongly advised step is to get yourself a credit card in the name of the company. That makes it easy to keep a clear distinction between business and personal expenses.

    As for what you can deduct, talk with a CPA for that. But yes, there are lots of things you can deduct like lunch with a client, the printer you print out invoices on, etc.

    Oh, and one other detail. If you're contracting you need to ask for more money than as an employee. Employers get employees at a substantial discount because they offer security and stability. Contractors get neither security nor stability and therefore can't afford to offer that discount. You have to charge enough to cover time you are not working, clients who do not pay, etc. A general rule of thumb in IT around here seems to be that for short-term contracts you can ask about double what you'd make as an employee. (Ideally double what you'd make counting benefits.) Calculating this is surprisingly simple. Suppose you make $X/year as an employee. Full-time you work 40 hours a week, 50 weeks per year, or about 2000 hours. So you're asking for $X/2000*2 = $X/1000. For longer-term contracts you will often work at a discount to this.

    Oh, and good luck.

Re: Should a consultant incorporate (and how)?
by mikelieman (Pilgrim) on Jan 09, 2009 at 18:50 UTC
    I read thorugh the relevant NYS Law about Sole Prop. LLCs, and did that filing myself.

    I have a CPA who prepares all the annual forms -- I handle the sales tax remittance quarterly filings myself.

    He gives me, every year, a collection of estimated filings for the upcoming quarters.

    Oh, yeah. Sales tax authority... You want that. Maybe your banker/credit union can hook you up with a credit card merchant account for 10 bucks/month + usage or something. THAT comes in handy occasionally ( Yeah, we take Amex... )

Re: Should a consultant incorporate (and how)?
by dsheroh (Parson) on Jan 10, 2009 at 15:26 UTC
    I've been freelancing for a bit over 4 years now, although (as of a week and a half ago) I'm no longer US-based. My US corp still exists, though, so...
    • I set up shop as an S-corp, just about the time the LLC craze was getting started. Most folks seem to be going LLC these days, but I can't really say that I know the benefits or drawbacks in doing so.
    • It does seem to be an easy thing, but I asked my accountant for a referral to a lawyer and he pointed me to a guy who was able to get me set up with all the paperwork done right for a total of about $300, IIRC.
    • While in the US, I paid myself a salary of $24,000/year and took any extra money out of the company as profit distributions. Doing it this way meant that, although I still had to pay income tax on everything, I only had to pay social security and payroll taxes on the base salary amount.
    • Yes, you can deduct all business-related expenses as, well, business-related expenses. Your accountant will know the details of what is and isn't allowed as well as how it should be recorded. (Note that, as already mentioned, deductions just mean that you don't have to pay taxes on that money. It doesn't make the deductible items free, but it is (effectively) a 30-40% discount, depending on your tax bracket.)
    • No, you don't need an accountant. But you really, really do want one. It will make your life much easier and, if you get a good one, the money you spend on his services will be repaid many times over in savings on your taxes.
Re: Should a consultant incorporate (and how)?
by Jayson (Novice) on Jan 11, 2009 at 21:23 UTC
    Oddly enough, Bear Stearns managed to put me out of work, too, through the fallout, I live in NJ and am looking at consulting again, too. :) We're probably looking at the same job market so I'll give my perspective.

    There are those who "consult", but are actually W-9 employees of consulting firms. It doesn't look like you'll be trying those and want to investigate life as a 1099. I consulted for two gigs for three years at major banks. I've made about every mistake you can on your own when creating a corporation so have paid my dues (read fines). You can do everything on your own it will just cost you money for mistakes. Fortunately, it's all a business expense. :-/

    Yes, you can create your own corp and it will be fine. Be prepared for an avalanche of snail mail and to stay consistently on top of it. I didn't, but I learned. I created my own S-Corp and somehow I managed to screw it up and got different employer identification numbers between the Federal and NY systems. A paper war later that was resolved. At least that problem didn't cost much money, but I needed my accountant to explain to me what the disaster was.

    LLC's are in vogue now because there is supposedly an increase in audits on S-Corp's. But statistically speaking, that's like being twice as likely to be struck by lightning where the odds are still next to nil. (given that you aren't doing any fancy bookkeeping).

    If you think personal taxes are dreadful, wait til you get to do the same thing four times a year. It's not a catastrophe if you don't, you just get fined. :) Ultimately, you will gleefully pay extra for an accountant. The only trick is finding a good accountant. One who will explain things to you and not magically provide you a dollar figure for a refund. Some accountants *are* lawyers so you can avoid the attorney cost. Mine works in a law office so I get the same benefits. At least I think so. I never hired an attorney, I never needed one.

    Your corp will pay you a salary, it's a myth that you will sidestep Social Security and other taxes by paying a dividend to yourself rather than a salary. It all works out the same unless you want to increase your chance of getting struck by lightning.

    Yes, you can deduct everything. In this process you will learn that you can deduct *everything* (is that a storm cloud cloud overhead?). In many cases, you can deduct buying books, etc as a W-9 employee. In a corporation, even more so.

    I wouldn't worry too much about getting audited or getting sued for your work. Yeah, it happens, but thinking about those things will paralyze you from taking action. The worst thing that would happen from an audit it that you pay more taxes and fines. And if you screw something up so badly that a giant bank sues you, your corporation won't protect you anyway.

    Your time should be spent worrying about getting gigs and collecting money for your work. Good luck! And private message me if they need two consultants. ;)

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