Mark Pestronk
Q: I am an independent contractor (IC), and my host agency is requiring that I set up my own corporation or limited liability company (LLC) by year's end. First, what's the point of my doing so? Second, which one should I set up, a corporation or an LLC? Third, in what state should I set it up? I keep reading about the advantages of setting up an LLC in Delaware, Nevada or Wyoming, although most of these articles and ads are written by lawyers who want business. What is the real story?
A: Your host's requirement is a wise one for both the host and you. For the host, having you work through a corporation or LLC makes it much less likely that a state taxing authority will reclassify your relationship as one of employer and employee. Such a reclassification would require the host to make withholding tax contributions and probably require the host to pay penalties for past noncompliance.
As an IC, if you don't want to be deemed an employee of the host (and I am sure you don't), then it pays to become an employee of your own business. In addition, working through a corporation or LLC protects your personal assets from liability for breach of contract and other misdeeds.
As for choosing between a corporation and an LLC, you should probably choose an LLC for two reasons. First, there are few or no follow-up formalities that you need to observe in order to operate your LLC in compliance with the law, whereas with a corporation, you should be issuing stock, doing annual meetings minutes (as silly as they are if you are the sole owner) and taking other steps depending on the law of the state in which you set up.
Second, with an LLC, you can choose to continue to be taxed as a proprietorship; i.e., you can continue filing a Schedule C as part of your personal federal tax return. Although such a filing makes the transition to the LLC much easier for you, I don't recommend it, because Schedule C filers are much more likely to get audited by the IRS than LLCs that get taxed as separate entities like corporations do. An audit may mean that any travel expenses that you claimed will get disqualified.
Specifically, your odds of being audited as a Schedule C filer are three times as high as they are if your company is taxed as a separate entity, either an LLC or a corporation. These odds will change if the IRS gets the additional funding that President Biden wants, but a Schedule C filer will probably stay a bigger audit target.
An LLC formed in Delaware, Nevada or Wyoming also must register as a foreign (i.e., formed out-of-state) LLC in the state in which you are located. This double-filing requirement negates any benefits offered by these three states, such as low filing fees, low taxes and anonymity. Tax benefits won't extend to business income generated in your state, anyway.
So, unless your attorney advises you differently, you should always establish the LLC in your home state.