Business Tips for Small Contractors
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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. Staying small is not the goal of most contractors. This doesn’t have to be a stressful decision, but important tax and legal considerations come into play, so it’s good to do your research.
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. Consideration should be given to set-up costs, liability and investments. We will go into a summary of these trade-offs later in this article. Set-up, liability, and investments are few of the main consideration. 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? Although the question may appear frightening, it should be a serious consideration.
In terms of tax preparation, the sole proprietorship is the easiest. You’ll be filing 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. Laying dpwm ground rules is an important part of planning a strong partnership and requires that you establish definite roles and commitments and how profits will be split. 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. Most contractors will find that joint ventures don’t apply as they are intended for one-off situations. 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. Partners are not employees and therefore are not issued W-2s from the business. Profits pass through the business directly to the partners in this kind of business structure.
Corporation
Corporations are entities considered separate from those who own and/or run it. As shareholders, owners assume limited liability. Corporations have an elected board of directors who must meet regularly and determine and oversee policy-making and enforcing. 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. 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. 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. Many small business owners find that the limitations of an S Corp are with the limitations.
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. As a rule most contractors want to grow their business.”
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. Business growth for small contracting firms may depend on the business structure that he/she decides on. If you decide later that the legal structure of your business is not appropriate, it is possible to change it. This can be time consuming and expensive and confusing to the government.
Discussions with a knowledgeable lawyer can help you think through the consequences that each business structure provides.
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