Once you decide to go independent, the first major decision you face is how
to incorporate. You were planning on it, weren’t you? Incorporating can
provide tax, legal and professional benefits that non-incorporated
contracting cannot.

Let’s talk about incorporating your company and then let’s talk about
lunch. While we won’t cover every type of legal structure your company may
have, we will discuss the most likely options.

Deciding on a legal structure will be one of the first decisions you make
as an independent contractor. Why? Because a bank won’t open an account for
you without this information, your home state won’t let you register
without this information and because your accountant may be slightly
interested in knowing what your intentions are. Of course, you may decide
to remain a completely independent contractor and not incorporate and do a
straight W2 much like a temp employee.

Speaking of accountants, this guy can give you the full run down based on
your particular case as well as your needs, but odds are a CPA is going to
suggest either registering as a sole proprietor or an s-corp. Whatever you
decide, be sure to let your accountant know what route you choose. A good
CPA will also be able to help you file all the necessary paperwork. Don’t
be afraid to use your accountant’s services, that’s why you’re paying him
each month for his services.

What’s the difference between these two legal structures? Well, there are
quite a few, from legal to financial to nomenclature.

Paperwork considerations

Being a sole proprietor may be a good bet for someone just starting out and
who doesn’t have a lot of cash on hand or doesn’t want to invest too much
in case things don’t work out. As a sole proprietor, you have less
paperwork that an s-corp and finances are a bit easier.

The paperwork required varies from state to state, so I won’t bother
telling you what specifically you’ll need, but your Secretary of State can
provide all of this information on line. At the end of the day, once you
have applied and received your EIN (you can get this within 5 minutes), you
are good to go. Your EIN is like a professional equivalent of your SSN.

Finances

As a sole proprietor, finances are a bit different. Depending on the bank,
some may or may not be willing to open a business account for you. In fact,
some may require you to be an s-corp before opening an account. Once you do
find a bank and settle in, you can breathe a little easier. One of the big
accounting differences between a sole proprietorship and an s-corp is that
you don’t have to justify every expense to the IRS. That doesn’t mean,
however, that you shouldn’t keep track of every penny. For example, if you
decide to withdrawal $20 from your professional account as a sole
proprietor, go for it. Uncle Sam will not be up in your grill. As an
s-corp, however, you cannot do this. Or you shouldn’t be.

As a sole proprietor, you are taxed one time on your earnings. As an
s-corp, your company pays taxes on the money you bring in and then you, Joe
Q. Public, are taxed on your earned income that your company pays you.

Legal

As we mentioned in
another article,
there are some legal protections that s-corp entities have that sole
proprietors do not. For example, should another party decide to sue you,
your personal assets are protected when you are an s-corp. As a sole
proprietor, you run the risk of losing everything but your dog (who may end
up running away when the repo man takes away his favorite sofa).

As a sole proprietor, you can make the argument that you are not your
company, especially when it comes to issues like paperwork and other
background information. However, please be aware that if you are taken to
court, good attorneys will probably succeed in “piercing the corporate
veil” without breaking a sweat.

In short, if legal guarantees and asset protection are truly a concern,
s-corp wins hands-down. Now, that said, let’s be honest for a second.
Someone who is writing a quick start manual for a small company probably
doesn’t need to worry as much as someone developing an enterprise
application for a Fortune 500 company. For the former, the indemnity clause
that you had put in the contract should suffice to protect you.

Negotiating contracts

As an s-corp, you are allowed to refer to your company as “inc.” We can
debate whether the benefits are real or imagined, but many people find that
“inc” tacked on to their company as more professional sounding. Some
clients feel the same way.

As my colleague and fellow purveyor of fine all-you-can-eat buffets
illustrated in

another article,

there are protections that s-corp registration allows. For example, some
clients will only do “corp to corp” (1099) for contractors that are
registered s-corp entities. If you are a sole proprietor, they may only be
willing to work with you as a W2.

As you can see, there are some fairly important issues to consider as you
start to file your paperwork. The best advice will come from a CPA, but
it’s definitely worth listening to the experience of others. Just keep in
mind that your mileage may vary and what’s right for one colleague isn’t
necessarily right for you.