Legal Considerations for Consultants

A sole proprietorship is any business operated by one single individual without any formal structure or registration requirements. A sole proprietorship is the simplest and least expensive business legal structure when you are starting out. It is also the easiest because it requires less paperwork and you can report your business income on your personal tax return. One drawback to this type of business is that you are personally liable for any debts of the business.

Without going through any formal processes, you can begin your consulting business simply by getting the word out that you’re in business. But you’ll still need a business license to conduct business.

Pros

• Easy to start
• Low start-up costs
• Flexible and informal
• Business losses can often be deducted from personal income for tax purposes

Cons

• Unlimited personal liability: the sole proprietor can be held personally responsible for debts and judgments placed against the business. This means that all personal income and assets, not just those of the business, can be seized to recoup losses or pay damages.
• All business income earned must be reported and is taxed as personal income.
• More difficult to raise capital for the business

A partnership is precisely as its name implies, a business venture entered into by two or more people with the intent to carry on business and earn profits. Partnerships can be beneficial for consultants as the workload and finances can be shared, and partners with differing areas of expertise can increase business opportunities.

You must register your partnership with a corporate registry. This does not mean that you must incorporate, only that you are making a formal declaration of entering into business with another person or persons. Be sure to consult your local business registry and a lawyer specializing in business registry. The primary purpose for doing this is for each partner to protect himself or herself concerning issues such as sharing profits, liability and dissolving the partnership equitably.

Pros

• More initial equity for start-up costs
• Broader areas of expertise can lead to increased opportunities
• Lower start-up costs than incorporation
• Some tax advantages

Cons

• All partners are equally liable for the other’s mistakes with the same liability as a sole proprietorship
• Profits and losses must be shared
• The business must be dissolved and reorganized when a partner leaves

Beyond any legal issues, before going into business with a partner you should spend many hours talking about how you will work together, including:

• What each of you will be responsible for
• How you will make decisions on a day-to-day basis
• What percentage of the business each of you will own
• How you see the business developing in the future
• What you expect from each other

During your discussions you can learn if there are any areas where you need to compromise. For example, one of you may want to start your business as a part-time job, while the other wants to work full-time and eventually build a business that will employ a dozen or more people. You can avoid future misunderstandings by putting the points you have agreed on into a written “partnership agreement” that covers any possibility you can think of (including one of you leaving the business at some point in the future).

Incorporation of a business means that a separate, legal corporate entity has been created for the purpose of conducting business. Like an individual, corporations can be taxed, sued, can enter contractual agreements and are liable for their debts. Corporations are characterized by shareholders, a board of directors and various company officers.

 As such, ownership interests can be freely transferred.

Creating a corporation requires filing of numerous documents to legalize your consulting business, as well as formally naming a president, shareholders, and director(s), all of whom can be a single person as set out in the company charter. As the rules and forms required for incorporation vary from state to state and province to province, it’s best to consult your local business licensing office or a local lawyer specializing in incorporation.

While it is probably best to seek legal expertise when incorporating, if you have the expertise and knowledge, you can incorporate your own business or use one of the many online resources that specialize in these matters. There are a few websites offering such services, often for only a couple of hundred dollars:

Although some business consultants do not see the necessity for incorporation, others like Pat Curley of St. Lawrence Business Consultants Ltd. see it as a must for anyone entering independent consulting:

 “I incorporated my consulting business right away. I wanted to protect myself and my personal assets from liability. I strongly recommend incorporating.” — Pat Curley St. Lawrence Business Consultants Ltd.

Pros

• Protect personal assets and income from liability by separating your business income and assets from your personal
• Corporations get greater tax breaks and incentives
• Ownership can be sold or transferred if the owner wishes to retire or leave the business
• Banks and other lending institutions tend to have more faith in incorporated businesses so raising capital is easier

Cons

• Increased start-up costs
• Substantial increase in paperwork
• Your business losses cannot be offset against your personal income
• Corporations are more closely regulated

An S Corporation is similar to the corporation in most ways, but with some tax advantages. The corporation can pass its earnings and profits on as dividends to the shareholder(s). However, as an employee of the corporation you do have to pay yourself a wage that meets the government’s reasonable standards of compensation just as if you were paying someone else to do your job.

A Limited Liability Company is a newer type of business legal structure in the U.S. It is a combination of a sole proprietorship (where there is only one member of the LLC) or partnership and a corporation, and is considered to have some of the best attributes of each, including lim ited personal liability.

An LLC business structure gives you the benefits of a partnership or S corporation while providing personal asset protection like a corporation. Similar to incorporating, there will be substantial paperwork involved in establishing this business structure. LLCs have flexible tax options, but are usually taxed like a partnership.

Pros

• Limited liability similar to a corporation
• Tax advantages similar to a corporation
• Can be started with one (except in Massachusetts) or more members like a sole proprietorship or partnership

Cons

• More costly to start than a sole proprietorship or partnership
• Consensus among members may become an issue
• LLC dissolves if any member leaves

Worker Safety Insurance covers for lost income and medical expenses in case of a work-related injury or disease. As a consultant, you will be working in various industries and occasionally, may require visits to work sites such as construction and warehouses which are considered higher risks workplaces. Therefore, it is in your best interest that you obtain insurance coverage in case of injuries sustained while at your client’s premises. Some of your clients may even require that you provide evidence of coverage as a condition of engaging your services.

Contact your local worker’s compensation board to enquire if you can obtain coverage through them. Here’s a list of the WCBs and their websites.

Also known as errors and omissions insurance.

It is important that you are protected against claims from your clients for professional negligent such as oversight, errors or incomplete work. Talk to your insurance agent about Errors and Omissions (E&O) Insurance, a type of Professional Liability Insurance. Most E&O covers legal expenses and monetary settlements up to the amount insured. Without E&O insurance, you will be exposed to risks of claims against your personal assets.

Health insurance covers medical expenses such as prescription drugs, hospital stay, ambulance costs and paramedical services. It is important that you get health insurance coverage including dental so that you’re protected against unexpected expenses, giving you peace of mind to get well knowing that there will be no or very minimal out of pocket expenses.

Individual health care plans are generally very expensive. Check with insurance companies if they have plans that are suited for independent contractors or consultants.  Another option is to check with your professional association if they have a pooled health benefits plan that’s available to members. The advantage of a pooled plan is rates are generally better than an individual plan due to a larger buying group.

Download the Brochure

Long Term Disability (LTD) is an insurance coverage that protects you from loss of income due to inability to work resulting from injury or illness for an extended period of time. As a sole proprietor of your business and especially if you’re the primary income earner in your household, income replacement is important to mitigate financial loss and ensure routine bills get paid.

Like healthcare plans, premiums for individual LTD plans are generally more expensive than those for group insurance plan offered by an employer to its employees.  Check with your professional association if they have a pooled LTD plan for members only that you can opt in to take advantage of the generally lower rate.

Property Insurance provides protection against risks to personal property such as furniture, household items and electronics arising from fire, earthquake and theft.  In the event of a break in to your house or office, you can claim against your Property Insurance loss of your computer, printer, cell phone and other office equipment. While mitigating against financial loss, this will allow you to get back to business with minimal down time.

If you’re incorporated or an LLC, you’ll require a business bank account with the name of your company.

If you’re a sole proprietor, you can use any type of bank account to pay for expenses and accept payment from clients.  However, it’s strongly suggested that you open a bank account where all business-related transactions will go through that account. You’ll have a hard time reconciling your expenses and earnings if you don’t separate personal from business.

It’s also strongly suggested that you get yourself a separate credit card that is used for business expenses only. 

You’ll need to be meticulous about keeping track of your revenue and expenses. It may sound easy, after all how many transactions could you possibly be dealing with?  But come year end, you’ll be grateful that you set up some kind of bookkeeping system.

There are a number of good accounting software solutions available for independent consultants.  Software companies have figured out that they were ignoring the independents and small businesses with their made-for-corporate offerings.  The software has become very easy to use and intuitive for us non-accounting types and have apps for your smart phone where you can enter in everything you do for a client by the minute, and upload images of expenses. It’s well worth the low monthly cost.

Check out www.Freshbooks.com 

Excel Spreadsheet

If you don’t want to invest in and learn new software, you can also easily keep track of your monthly billings and expenses by using an Excel Spreadsheet. You can create a new worksheet (or tab) for each month or each year. Just make sure you have one place where you have a list of all your billings for the year. 

As a non-employee, you’ll be able to write off expenses that directly relate to your conducting of your business.  Aside from the expenses outline in Structure and Costs, here are just a few examples of expenses that you would likely incur even if you weren’t a consultant:

• Business mileage or business percentage of all vehicle costs
• Cell phone
• Computer equipment
• ISP

• Once you and your client have determined the contractual billing frequency, set a re-occurring reminder in your calendar to ensure you remember to invoice your clients. It’s easy to forget.
• If you don’t have accounting software, use the Invoice template to generate an invoice. Additional instructions are outlined on that page. 

Here are some of the ways you can accept payment for your invoices from your client.

• If you’re using accounting software like Freshbooks.com, you can accept credit card payment.
• Email e-transfer.  Most banking institutions now have email e-transfer payments available where through online banking. If you’re client is a small business, they may use this as a quick easy way to pay your invoices. In this case, you would not have to provide your client with any banking information. 
• Direct Deposit.  Many businesses are now using direct deposit for vendors.  They will ask you for your banking information and your payment for your invoice will be deposited directly into your bank account. 
• Check.  We recommend you don’t accept checks as a payment method and that you stipulate this in your contract with the client. You will get paid much later and ‘the check is in the mail’ is an easy excuse to defer your payments.  If the client has every intention of paying you on time, they will accept this term.