Normal 0 false false false EN-US X-NONE X-NONE

At some point in every small contracting business, a decision has to be made on how to structure the business for growth. Although some contractors prefer to remain a one man operation, most would prefer to see substantial growth. 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. Legal opinion is necessary to understand the ins and outs of liability issues in 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. Sole proprietors own all assets and profit from the contracting 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. Using the individual 1040, Schedule C (or C-EZ) and Schedule SE for self-employment tax is a necessary filing requirments for sole proprietorships. 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. Making decisions, establishing and defining roles and commitments, and profit allocation are some of the decisions that need to be made when planning a partnership. 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. Take the time to write up an agreement before establishing a partnership.

There is more than one type of partnership, too. There are general partnerships, limited partnerships, and joint ventures. Joint ventures are intended for a limited time or one-off situations, and most likely will not apply for a contracting business situation. Limited partnerships require that one or more of the partners assume a limited role in decision-making but also limited liability. 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. Otherwise each partner in the partnership files the 1040, and self-employment and estimated tax forms, showing individual profits from the partnership. W-2s are not issued to partners as they are not employees of 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. Shareholders or owners must assume limited liability. Corporations must elect a board of directors that meet regularly to provide oversight for both policy making and enforcement. Corporations take a lot more work to set up and maintain, from the initial paperwork filing to the yearly taxes, which can end up being higher. Corporations also make it easy to raise capital through the sale of stocks to transfer ownership to another party. 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. One downside to corporations is the tax consequence of being taxed on both the corporate income and salaried income.

A subset of the corporation business structure is the S Corporation, or Subchapter S Corporation. In this structure, the earnings and profits of the corporation are passed directly through to the shareholders (owners) and their individual tax return. 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. “The easiest solution is a sole proprietorship,” says Macmichael. “It’s easier to set up, easier to deal with payments, and doesn’t cost the money that incorporating costs.The convenience of a sole proporietorship far outweigh the liability risks associated with a sole proprietorship to MacMichaels. “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. Obviously remaining a small business is not the goal of most contractors.”

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. A small contracting business owner should understand that his business growth may depend on how he structures his business. The legal structure of a business can be changed at a later date if it becomes necessary. If changing the businesss structure becomes a necessary, good accounting practices are crucial.

Our advice is to discuss this thoroughly with an attorney and think through what each structure will require for record-keeping and how much protection they provide against lawsuits.

Another option you might want to check out is the ContractorBlab