BOSTON (05/23/2000) - At some point along the way, every independent consultant has to decide whether to remain a sole proprietor (known as a 1099 for the tax form he uses) or to incorporate. The question tends to elicit strong opinions - or it inspires fear and confusion and is thus avoided altogether.
As a sole proprietor, you face liability issues. Unless you have a solid liability insurance plan, your personal assets may be vulnerable if a client sues you.
Incorporating can provide a veil of protection by establishing the business and the owner as two separate legal entities. It also makes it easier to position yourself with clients as an independent consultant rather than a W2 (staff) employee.
Computerworld asked three consultants and a tax expert if independent consultants should incorporate. Here's what they said, yea or nay:
THE ACCOUNTANT: Nay
Juda Kallus, enrolled agent
Kallus is an accountant who specializes in tax issues for self-employed individuals. Approximately 50 of his clients are independent information technology consultants and contractors. His Web site (www.judakallus.com) features tax tips and advice for 1099s and W2s.
"I generally discourage my clients from incorporating unless there are liability issues, because incorporating may not necessarily reduce your taxes, but it exponentially increases your paperwork and [tax] filing requirements.
"If you set up a corporation, the income is now earned by the corporation, and you can't just take money willy-nilly from your business. Instead, you have to pay yourself a salary and deduct all the required taxes. And the burden of running a payroll can overwhelm even a savvy IT professional.
"You must withhold tax for federal, state and local authorities; your business must be registered with state unemployment insurance; you must cover employees with mandatory disability and workmen's compensation insurance, which varies from state to state."
THE LLC PRINCIPAL: Nay
Louis Storms, president
Plan Three Solutions LLC
Storms originally formed Plan Three in March 1999 with friend and colleague Scott Peterson. They expected to work together as independent consultants and eventually bring in other consultants. The business, which specializes in Web-site design and development, grew much faster than expected; Peterson sold his share to Storms, who now has 13 employees.
"Don't incorporate and don't form an LLC [limited liability corporation] unless you're going to have employees. Why go through the hassle? If you're a sole proprietor worried about liability, then weigh the administrative costs of a corporation or an LLC vs. the cost of really good, powerful liability insurance.
"Everything changes when you hire your first employee. You have benefits issues; you have to withhold payroll taxes. You can spend a tremendous amount of time just on payroll issues. If you can't stomach about 15 hours a week in administrative overhead, then remain a sole proprietor."
THE SOLE PROPRIETOR: Nay
Scott J. Peterson
An independent sole proprietor specializing in Visual Basic developmentHouston(www.vbdeveloper.net)"Personally, I have wanted to avoid any sort of large-organization mentality or headaches. I've started two different companies, and each time I wasn't satisfied. Even as the sole shareholder, you still have all the mental burdens of having a set of dynamics outside your [actual] work. It's easier for me to be an independent, pay someone to do my taxes, and just be done with it.
"In IT, there's such a high demand for folks like me that we literally spend all of our time being billable, and we can't afford the time you have to spend doing anything that's not related to earning revenue.
"The term I would use for the [paperwork] requirements for someone who incorporates is abusive. The majority of things involved are unnecessary for someone who's running a successful business - the tax forms, the payroll paperwork, all the rules and regulations and the money you have to spend making sure you're in compliance. You can subject yourself to that abuse, but I don't think there's any value added."
THE INCORPORATED SOLE SHAREHOLDER: Yea
Paul Reiter, president
Reiter and his wife, Brenda Martin, are the sole shareholders of RC3, a C corporation that Reiter formed in 1993, after five years as an independent sole proprietor. Reiter is a senior systems consultant specializing in performance tuning, and Martin is an independent IT project manager.
"I incorporated originally so I could be paid directly, corporation to corporation - by IBM at the time. I was working for the First American Bank in Nashville, Tennessee, [as a subcontractor] on an IBM outsourcing deal, and the bloodsucking agency that I worked for let the contract lapse. So, I told IBM I would work for them directly, and they said OK, but only if I were incorporated.
"So I did it. IBM cut me the same deal that it had had with the agency, so my rates went up. The corporation-to-corporation arrangement is less of an advantage now [since most companies use a preferred-provider list to hire contractors]. I still go through agencies, but I invoice them. If an agency won't pay me on a corporation-to-corporation basis, I don't deal with them.
"But there are other benefits. My corporate taxes are 21%, whereas my personal profits as a 1099 would be 37%. So, I let my corporation retain the profits, and it pays my wife and I an annual salary of $60,000 each, so we stay in the 25% tax bracket. And the wages paid by the corporation are considered a deductible expense. My opinion is that if you're a 1099, you're not serious about your business. If you've been around the business a long time, you should be incorporated because you carry more weight. And, you can command a higher rate as well."