Legal Entity Formation for Growth Marketing Contractors

Right Side Up recently hosted a webinar on legal entity formation for growth marketing contractors, led by Alex King, Founder and Principal Attorney of Archetype Legal PC. Alex shared his advice on the practical legal steps entrepreneurs, startups, and small businesses can take to achieve their business goals. For a detailed breakdown of everything you need to know about legal entities, watch the full webinar. 

A brief disclaimer before we dive in: as with any legal decision, remember that each and every business situation is unique and you should consult a professional before making any decisions about forming a business entity. This article should not be viewed as a substitute to working with a legal and/or professional, or construed as legal and/or advice. 

As more people ditch their full-time gigs for a career as an independent growth marketing contractor, one of the biggest (and most important) questions they’re likely to ask themselves is, "Should I form an LLC for my marketing consulting work?" There are a range of options for contractors to create a legal business entity and take advantage of tax savings, including a sole proprietorship, limited liability company (LLC), and C-Corporation. But which one is right for you? And how do you get the ball rolling? 

Benefits of Forming a Legal Entity as a Marketing Consultant

Independent contractors aren’t required to form a legal entity by law, but there are several benefits in doing so. When deciding whether it’s worth it to establish a legal entity, one of the biggest indicators is income. If your income is under $30K, it’s probably not in your best interest to invest in setting up a legally recognized business. If you’re in the $50K range it’s smart to explore creating a legal entity. And once you begin to approach six figures, you should seriously consider it, for both the legal protection and tax savings.

Limited liability protection

If you work as a consultant and don’t have a legal entity set up for your work, all of your client contracts are legally binding agreements between you as an individual and them as a company. That means your personal assets—like your car, house, and savings—could be at risk if you were ever involved in a lawsuit or legal dispute with a client.

By forming a legal entity—specifically an LLC or C-Corp, your contracts can now be between that entity and the client. That creates a shield that protects your assets and ensures that all legal action will be limited to the entity and not you personally.

“What happens when you form an LLC or a corporation is that you’re creating a separation between you and your business,” said Alex King, who led the webinar. “Creating this shield can go a long way if you have a big whoopsie that would result in large liability.”

And the liability protection doesn’t just apply to clients. It also protects you from personal liability in situations involving other consultants, employees, or third parties you do business with.

Tax savings for marketing consultants

Each type of legal entity offers its own tax advantages and we’ll break down the specific tax benefits of each legal entity type a bit later. But it’s important to note up front that an S-Corporation is not a legal entity itself—it’s a tax election that can be used for both LLCs and C-Corps.

Perceived legitimacy and marketing benefits

Creating a legal entity for yourself can help you build a more professional brand. Even if your business is just you in sweats at your home office, having an official business name and legal standing can lend legitimacy and credibility to your work.

“It gives more cache and prestige to say you’re working with Archetype Legal than it does to say that you’re working with Alex King, the lawyer, as a sole proprietor,” King said.

Sole Proprietorship Offers a Simple Business Structure

A sole proprietorship is the simplest structure for creating a legal entity for your business. You are your own boss and your sole investor (for better or worse).

However, with this option, you’re responsible for all of the liability of the business. And a sole proprietorship doesn’t allow you to utilize the potential tax savings afforded to an entity that is classified as an S-Corp.

And while it’s great to be your own boss, if you ever want outside help it will be difficult to convince sophisticated investors to invest in your business with this simple structure.

Although taxes are fairly straightforward with this entity, there are a few things to keep in mind:

• All taxes on business income are paid on your personal tax return.
• Sole proprietorships are taxed on all profits—total income minus expenses.
• Expenses can be deducted and you can write off certain costs, like equipment purchased for the business.
• Business profits and loss information must be listed on a Schedule C form that’s submitted to the IRS along with Form 1040.
• Some sole proprietorships may qualify for a new pass-through deduction where up to 20% of the business income earned can be deducted as an additional personal deduction.

Limited Liability Company Has Valuable Flexibility

LLCs are commonly used by independent contractors and are typically a good fit for marketing consultants. This legal entity is a great choice because it offers more benefits than a sole proprietorship while remaining more flexible and simple than a C-Corp. In an LLC, members aren’t personally liable for the actions of the company and your personal assets are protected from creditors. 

Because it’s not a corporation and is instead a product of contract law, an LLC allows you to set up an ownership structure that makes sense at both the business and tax levels. And profits and distributions don’t need to mirror the percentage ownership of each owner.

This legal entity doesn’t require you to set up a board of directors, hold shareholder meetings, or keep a record of those meetings. It’s also easier to set up than a corporation, making it more cost effective to gain the limited liability you want while also benefiting from more favorable tax treatment.

If an LLC is owned by only one person, it’s taxed as a “disregarded entity,” which means the IRS will tax you on a Schedule C, just like a sole proprietorship. All profits and losses flow directly to the individual owner. However, if your LLC is owned by more than one person, the default tax structure is a partnership, with individual partners paying taxes based on their share of the ownership of the business.

LLC limitations

The LLC business structure is a great option for many individual contractors and small companies, but there are a few drawbacks to consider:

• Courts could rule that your LLC doesn’t protect your personal assets if you don’t clearly separate the business and personal transactions.
• Members are personally responsible for paying Social Security and Medicare taxes, which are essentially collective “self-employment taxes” based on the businesses total net earnings.
• In many states, if a member leaves the company, goes bankrupt, or dies, the LLC has to be dissolved and the remaining members are responsible for all legal and financial obligations necessary to terminate the business. If the remaining members want to continue the business, they must start a new LLC.

C-Corporation Allows for Raising VC Funds

A C-Corp is more complicated and more expensive than other structures, but it also opens the door to bigger opportunities in the future. A C-Corp is typically only worth it if you plan to raise venture capital funding for your business.

“As an independent marketing consultant, you’re almost never going to want to be a C-Corp,” King said. “It’s only good if you’re doing something like a traditional tech startup and plan to take on VC funding, but that’s almost never going to happen for a small consulting business.”

There’s a higher cost upfront to get a C-Corp started and it’s also more complicated and expensive to maintain on an ongoing basis than other legal entity forms. C-Corps must follow a wide range of regulations at the federal, state, and local levels. That means you’ll need to devote time, money, and resources to keeping close track of tax, business, and financial records, drafting corporate bylaws, issuing annual reports, and electing a board of directors. 

This structure is also subject to double taxation, so you’re taxed at both the personal and corporate levels. C-Corps make sense for startups with big goals, but because of their complicated nature, expensive set up and maintenance requirements, and double taxation, they’re rarely the best choice for an individual consultant or small business.

When to Use an S-Corp

An S-Corp is not a legal entity, but it is a tax structure that can be beneficial in certain circumstances. This type of tax election allows profits and losses to flow through to the owners and is commonly called “pass-through taxation” as it only requires one level of taxation.

Entities using an S-Corp can only have a maximum of 100 shareholders and all shareholders must be actual people (not other legal entities) that are US residents.

To determine whether it makes sense to create an S-Corp, you’ll have to take a look at:

• Your type of business and projected revenue
• How your business will grow and evolve from an ownership and profit standpoint
• If the business will need an infusion of capital in the near future

Location-based Tax Loopholes Aren’t (Usually) Worth It

We’ve all heard the common idea that incorporating a business in certain locations—like Delaware or Nevada—can offer a miracle solution for avoiding or minimizing those pesky tax bills. But for the majority of business situations, trying to use this approach causes more problems than it’s worth. In a small percentage of cases, foreign registration can work, but it’s almost always tied to raising capital.

If you do choose to form a legal entity outside of your home state, be prepared to:

• Complete and file separate foreign LLC registration forms and pay statutory fees in any states in which your LLC will be doing business.
• Retain and designate a registered agent for the LLC within the state(s) of formation and pay initial and ongoing registered agent fees.
• Potentially be double taxed if you end up having to pay taxes in both the foreign and home state if you transact business in multiple places.

This is a complicated and risky route for those who don’t know what they’re getting themselves into. So make sure you know what you’re doing (or hire someone that does) before forming a legal entity outside your home state.

Retirement Options for Independent Contractors

Most employers offer some type of retirement plan for their full-time employees, but when you work for yourself, it’s all up to you. There are several options to consider as an independent consultant:

• IRA (traditional or Roth)—Explore this option if you’re just starting out or if you have limited funding for your retirement plan. The contribution limit is $6,000 (as of 2021) and bumps up for $7,000 for people 50 years old or older.
• Solo 401(k)—This is best for a business owner with no employees. There’s a contribution limit of $58,000 (as of 2021), plus a $6,500 catch-up contribution or 100% of your earned income, whichever is less.
• SEP IRA—Consider this product if you’re self employed or a small business owner with no or few employees. The contribution limit is the lesser of $58,000 (as of 2021) or up to 25% of compensation with a $290,000 income cap.
• Simple IRA—This one is geared toward larger businesses with up to 100 employees. The contribution limit is $13,500 (as of 2021). And if you also contribute to an employer plan, the total of all contributions can’t exceed $19,500.
• Defined benefit plan—If you’re self employed with no employees and have a high income, this approach lets you save a lot for retirement. Your contribution is calculated based on the benefit you’ll receive at retirement, your age, and expected return.

Regardless of whether you form a sole proprietorship, LLC, or C-Corp, creating a legal entity for your business can help limit your personal liability and allow you to take advantage of tax benefits. Just be sure to choose the option that fits best with your current and future business needs. 

Interested in joining our team of A+ growth marketing consultants? Drop us a line at hello@rightsideup.co. And if you’d like to get in touch with Alex King, you can reach him at alex@archetypelegal.com.