Author Topic: Setting up a LLC - why, what for and how? (Consulting work)  (Read 1959 times)

nereo

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Setting up a LLC - why, what for and how? (Consulting work)
« on: August 10, 2016, 08:37:51 AM »
I very recently was contacted about doing some consulting work over the next few months. If the first contract goes well there is the potential that this could turn into a sizable income stream for me - potentially becoming my primary source of income.

For the first contact I'm just being paid as an individual, but I've been told I might want to look into setting up my own LLC if I plan on doing this long term.  I understand having a LLC protects my private assets (e.g. my home, vehicle, etc) from anything bad that happens with the consulting gig, but beyond that.... I have no idea.

My current list of questions (in no particular order)
1) how does one set up an LLC?
2) Will having an LLC give me better access to tax-deferred accounts (currently all I have access to is an IRA).
3) does it matter that I would literally be the only person in the LLC?
4) what are the downsides for having an LLC?
5) is there an income rule-of-thumb when an LLC becomes worth it?  hard to say right now but in 2017 it could be in the $30k-80k range.
6) would I be better off setting it up as an S-corp, C-corp or sole-proprietor?  FWIW my wife could be added, working on a limited basis (10-20 hours/month).

any input from individuals who have set up their own LLC for individual consulting work would be greatly appreciated.

Laserjet3051

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Re: Setting up a LLC - why, what for and how? (Consulting work)
« Reply #1 on: August 10, 2016, 10:09:55 AM »
I very recently was contacted about doing some consulting work over the next few months. If the first contract goes well there is the potential that this could turn into a sizable income stream for me - potentially becoming my primary source of income.

For the first contact I'm just being paid as an individual, but I've been told I might want to look into setting up my own LLC if I plan on doing this long term.  I understand having a LLC protects my private assets (e.g. my home, vehicle, etc) from anything bad that happens with the consulting gig, but beyond that.... I have no idea.

My current list of questions (in no particular order)
1) how does one set up an LLC?

File articles of incorporation with the state. Do it yourself (EASY) or pay someone else to do it for you.

2) Will having an LLC give me better access to tax-deferred accounts (currently all I have access to is an IRA).

Yes. Employer contributions to tax deferred accounts (paying yourself) could lower both your personal AND biz taxes. For example, SEPs are employer funded and can be added to the battery of retirment accts.

3) does it matter that I would literally be the only person in the LLC?

Yes, single member LLCs can receive different treatment (usually less protection) and can be disregarded under some circumstances.

4) what are the downsides for having an LLC?

In CA, COST. Min $800 annual tax payment even if no income.

5) is there an income rule-of-thumb when an LLC becomes worth it?  hard to say right now but in 2017 it could be in the $30k-80k range.

Yes, this depends on your states LLC tax rate and how your LLC chooses to be taxed. (s-corp has pass thru taxes). You have to do the calculation for your specific situation. If income ramps up, it might be more cost effective to start out as sole prop then transition to LLC, but this depends on YOUR specific situation. If you intend to hit $80 in the first year, sole prop will be a loss.

6) would I be better off setting it up as an S-corp, C-corp or sole-proprietor?  FWIW my wife could be added, working on a limited basis (10-20 hours/month).

LLC/s-corp has been working well for my consulting and IRS #s show that this form of biz is VERY popular in the US as revealed by total # of LLC/s-corp filers each year.

any input from individuals who have set up their own LLC for individual consulting work would be greatly appreciated.

I set up an LLC/s-corp hybrid for consulting and it has been working out well for me. answers are above in blue.

Axecleaver

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Re: Setting up a LLC - why, what for and how? (Consulting work)
« Reply #2 on: August 10, 2016, 11:21:59 AM »
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I understand having a LLC protects my private assets (e.g. my home, vehicle, etc) from anything bad that happens with the consulting gig, but beyond that.... I have no idea.
LLC's really don't help much in consulting. First off, make sure every contract you sign as a limitation of liability related to the value of the contract - you're shooting for 1x or less, industry standard is 1-3x the contract value. I've seen them as low as the value of billings for the last 90 days. Understand that even with an LLC, if you really screw something up (negligence, willful malfeasance) they can still come after you personally.

Once you're on firmer ground with the business, you're better off buying professional liability insurance (sometimes called errors and omissions insurance). You may also want general liability insurance, especially if you get to the point where you're hiring or contracting help. This together with worker's comp covers slip and fall type claims. My advice is to set up an S corp from the start, decide when to buy insurance, and avoid the paperwork, hassle and expense of an LLC altogether.

I think Laserjet covered most of the questions, here's what I'd add.
Quote
2) Will having an LLC give me better access to tax-deferred accounts (currently all I have access to is an IRA).
The LLC doesn't do that, but earning income from a side gig does. Whether that's under the banner of an S-corp, C-corp, or sole proprietorship claimed on Schedule C (what happens if you make money without a corporation being formed), you're eligible to set up a SEP IRA or Solo 401k. The Solo-k is usually a better option and lets you get to the 53k tax deferred limit quicker. Above a certain amount (in the 180k range?) they're functionally equivalent.

Quote
3) does it matter that I would literally be the only person in the LLC?
Yes, which is why I think S-corp is a better plan for you. You'll also save on payroll taxes vs being a disregarded entity.

Quote
4) what are the downsides for having an LLC?
More overhead to set them up, more paperwork to maintain, various states treat them differently and require different filings every year. Disadvantage of an S corp is that it requires a separate business return (an LLC filing as an S corp does, too).

Quote
5) is there an income rule-of-thumb when an LLC becomes worth it?  hard to say right now but in 2017 it could be in the $30k-80k range.
Depends on what you're making from your W2 also, but I'd say around 20k is enough to start getting things set up for future success. I'd get the S-corp established right away and evaluate your insurance options ASAP. Skipping the insurance means you're accepting the risk of a claim, just write your contracts the right way to mitigate this risk with or without insurance.

Quote
6) would I be better off setting it up as an S-corp, C-corp or sole-proprietor?  FWIW my wife could be added, working on a limited basis (10-20 hours/month).
C-corp won't be beneficial because of double taxation. S-corp is pass-through taxation and you get to take distributions to avoid payroll taxes. Paying your wife means you'll pay separate payroll taxes on her income, but also get to make retirement contributions for her; probably not what you want to do at 30-80k, but you have some options as the business ramps up.

I'll leave you with a few simple these rules may help you grow your business.

Axecleaver's Steps for Starting Your Own Consulting Business
WHAT
1. Cut your minimum monthly living expenses as deeply as possible.
2. Build up a transition fund to pay your expenses for 6-12 months.
3. Write a business plan: visit www.score.org for templates.
3a. Set your services and rates (1/1000th of your annual salary is a good starting point).
4. Identify customers.
5. Set meetings to sell your services. If you sell everything you pitch, then you're not pitching to enough people. Shoot for a 25% close rate.
6. Keep your day job and deliver on nights/weekends until you have at least 20-40h/week of deliverable work sold.
7. Incorporate your business.
8. Once your day job is impacting your ability to deliver, turn in your notice.
9. Purchase insurance: errors and omissions/professional liability, general liability
10. When your sales exceed your ability to deliver, add staff.
11. Hire a payroll service, HSA and 401k providers. (Caveat: explore Solo-K and SEP-IRA if you never intend to have staff.)

WHY
1. If you run out of money, you're going back to work for The Man for the rest of your life.
2. Most consultants bill monthly at the end of the month, on net 30 terms. Clients can take up to 45 days to pay. Large checks take seven days to clear. This means a job you start working on June 1 may not make funds available to you until August 22 - nearly 12 weeks.
3. A business plan template will ask you questions you haven't thought to ask yet - what are your services and what is your rate, who are your customers, how will you market to them, what does your staffing plan look like, will you offer products or just services, what margins will you use?
4. Use every resource at your disposal to find customers: your rolodex, temp agencies, headhunters, Craigslist, etc.
5. Pipeline management is a critical skill in the  consulting business. You should be selling services at least three months out, but this takes time to develop. You should always be selling.
6. Building a reliable customer list takes time. Deliver against your core services while keeping your day job. Get used to 80-100h work weeks.
7. S-corps are popular choices for consultants because it allows you to pay yourself distributions which avoids payroll taxes on a portion of your income.
8. Ease the transition into consulting by keeping your day job while you build your experience and customer list.
9. Protect yourself and your company with liability insurance. Many customers and prime vendors require it. Look for a million per instance in coverage as a starting point.
10. Hire staff as your company grows. Always be selling.
11. Outsource the administrative tasks that make the most sense.

Laserjet3051

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Re: Setting up a LLC - why, what for and how? (Consulting work)
« Reply #3 on: August 10, 2016, 02:45:19 PM »
Good advice axecleaver, though I have weighed the pros and cons of obtaining supplementary liability insurance (over that which is protected by my LLC) but given the specific nature of my work, I just can't justify the added cost of liability insurance. Sure, a client "could" come after me, but I deal only with mega-corps where anything less than $100,000 doesnt even show up on the corps radar. Even if I did break a $100,000 electron microscope, the service contracts the corp has on the equipment would cover it. But yes, the real risk of not having additional insurance is unknown.

laser

nereo

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Re: Setting up a LLC - why, what for and how? (Consulting work)
« Reply #4 on: August 11, 2016, 08:22:23 AM »
Thanks to you both for your comments - that's certainly given me a lot to consider over the next few weeks.

An additional question has come up:
Does it matter which US state I set my LLC up in? 

For background info - 95%+ of the work I will be doing will be telecommunicating, and it's almost entirely research based, and I can do it literally anywhere with good internet access. Most of my clients will come from the eastern US.  Currently I have a permanent address in Virginia, but logistically I don't know why I need to be tied to that particular state.

Axecleaver

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Re: Setting up a LLC - why, what for and how? (Consulting work)
« Reply #5 on: August 11, 2016, 09:59:45 AM »
It will probably be easier/less paperwork to create it in your domiciled state. I believe you'll need a third party registrar to file in a state you don't live in (I could be mistaken - haven't tried this). Some folks like to create corps in Delaware, but I didn't find the benefits worth the hassle. And since you'll be creating a disregarded entity, I don't think it really matters.

I would look into how Virginia deals with LLCs, specifically taxation and filing requirements. If it's negative, you could create it in another state, but the taxation will still get you because you have to declare income in the state where you performed the work. How they would audit that is a totally separate question.

Make sure to consider and file for the option to be taxed as an S-corp - you have a limited window to do that after establishing the LLC. If you miss the window, the filing cutoff is by September for the following tax year. You have to do this for the federal government first, then use that confirmation to file with the state. More LLC overhead you wouldn't have with a straight up S corp.