From Scientist to Solopreneur: Choosing the Right Business Structure for Freelance Consulting

Welcome to another weekly edition of Leapfrog Scientist!

In this issue, we'll explore the intricacies of launching consulting as a side hustle. We'll examine the reasons behind why scientists should consider freelancing as consultants and provide guidance on selecting the optimal business structure. This is the prequel to next week where we'll be sharing resources to assist you in finding paid consulting opportunities on the side.

Often, the biggest hurdle is taking the first step, and sometimes we get caught up in the logistics and deliberations over whether an LLC structure is necessary and how to even proceed. Our goal is to remove these mental roadblocks and offer practical guidance and encouragement.

It's important to acknowledge that the ideal moment to start utilizing your expertise through freelance consulting is while you're pursuing graduate studies or even when you're employed full-time. During these periods, you often have a safety net in place, which can mitigate the perceived risks associated with venturing into freelance work or becoming a solopreneur.

Why Scientists Should Consider Side Consulting

The knowledge and skills acquired during graduate school or on the job training can be transformed into valuable assets for generating additional income on the side and entrepreneurial success. Many researchers are increasingly turning their skills into entrepreneurial ventures.

Discovering your niche often begins with a thorough examination of your skill set. As a researcher, the years spent refining analytical thinking, problem-solving, and domain-specific knowledge lay the robust groundwork for entrepreneurial pursuits. However, the challenge lies in translating these skills into a viable business model. One approach is to begin addressing others' challenges using your specialized skill set, either at a reduced rate or by offering complimentary high-level consulting services. Through this process, you gain insights into your target audience, identifying their pain points, primary obstacles, and unmet needs. Once you pinpoint these areas, you've found your niche—the convergence of your expertise with a market demand. From there, you can dedicate your efforts to becoming the go-to expert in your niche. As you establish yourself, you can progressively raise your rates and develop tools and resources to offer others, thereby monetizing your expertise.

In addition to the monetary benefits, freelance consulting can open new doors to new connections and opportunities, thus expanding your network. Engaging in consulting projects allows you to stay updated on the latest trends and advancements in your field. You'll gain exposure to different challenges and perspectives, enhancing your problem-solving skills and broadening your professional horizons.

Business Structures

Before embarking on your entrepreneurial journey, it's crucial to address a fundamental question: Which business structure best suits your needs? Are you best served by an LLC, S-Corporation, or would a Sole Proprietorship suffice?

The answer depends on various factors, including liability protection, taxation, and administrative requirements.

Sole Proprietorships are the simplest and most common business structure, offering full control and minimal paperwork. scc591-70in.pdf (virginia.gov)

Operating as a sole proprietor means that your business income is seamlessly integrated into your personal tax return. This tax simplicity can be a relief for those unfamiliar with complex corporate tax filings. Moreover, the initial investment required to establish a sole proprietorship is often minimal, making it an accessible choice for individuals looking to test the waters without significant financial risk.

However, it's essential to tread cautiously when considering a sole proprietorship, as it comes with inherent risks. Chief among these is the exposure to personal liability for business debts and legal claims. Unlike other business structures that offer limited liability protection, such as LLCs or corporations, a sole proprietorship leaves your personal assets vulnerable to seizure in the event of financial or legal troubles.

Despite these risks, a sole proprietorship can serve as an excellent starting point for aspiring consultants looking to gauge the viability of their venture. It provides an opportunity to test the waters, refine business strategies, and assess market demand without the complexities associated with more formal business structures.

Forming an LLC (Limited Liability Company) is a strategic move for many entrepreneurs seeking a balance between personal asset protection and flexibility in management and taxation. An LLC offer a middle ground between sole proprietorships and corporations, making them a popular choice for many entrepreneurs. It separates your personal assets from business liabilities, shielding your personal finances in case of legal issues.

Unlike corporations, which often have rigid management structures and regulatory requirements, LLCs offer more freedom in how they are managed. Owners, known as members, can choose to operate the business themselves or appoint managers to handle day-to-day operations.

LLCs have the unique ability to choose how they want to be taxed. By default, LLCs are taxed as pass-through entities, meaning that business profits and losses are reported on the owners' personal tax returns. However, LLCs also have the option to elect corporate taxation, which may be advantageous in certain situations. Additionally, LLCs can choose to be taxed as sole proprietorships, partnerships, or S-Corporations, providing flexibility to adapt to changing tax landscapes and business needs.

Setting up an LLC involves some administrative steps, including filing articles of organization with the state, drafting an operating agreement to outline the management and ownership structure of the LLC, and obtaining necessary licenses and permits for the business. Additionally, obtaining an Employer Identification Number (EIN) from the IRS is typically required for tax purposes. Opening a business checking account is also recommended to keep personal and business finances separate, although not legally required.

Once established, LLCs must adhere to certain compliance requirements, such as filing annual reports and paying applicable state fees. While these obligations are generally less burdensome than those for corporations, they are important to maintain the LLC's good standing and legal protections.

S-Corporation is a tax designation that offers liability protection while avoiding double taxation. For individuals seeking heightened liability protection and favorable tax treatment, electing S-Corporation (S-Corp) status can be a strategic choice.

Similar to LLCs, S-Corporations offer a crucial shield between personal and business liabilities. This means that in the event of legal action or financial obligations incurred by the business, personal assets of shareholders are generally safeguarded from seizure.

One of the primary advantages of S-Corporations is their tax treatment, which helps to avoid the issue of double taxation commonly associated with traditional corporations. Instead, S-Corps allow business income and losses to pass through to shareholders' personal tax returns. This pass-through taxation structure can result in reduced overall tax liability for shareholders.

S-Corporations have more stringent requirements compared to other business structures, such as LLCs. For example, S-Corps must adhere to restrictions on ownership, with limitations on the number of shareholders and requirements for U.S. residency. Additionally, S-Corporations must follow formalities such as holding regular shareholder meetings and maintaining detailed corporate records.

S-Corporation shareholders who actively participate in the business must receive reasonable compensation for their services. This compensation is subject to employment taxes but is not subject to self-employment (SE) tax. It's important for S-Corp owners to carefully determine and document their compensation to ensure compliance with IRS regulations.

Unlike sole proprietors and LLC owners, S-Corporation shareholders who receive salaries must file quarterly payroll tax returns and make payroll tax deposits. This administrative requirement can add complexity to the operation of an S-Corp and requires careful attention to detail.

For new LLCs considering S-Corporation status, there is a window of opportunity to elect S-Corp taxation. Within 45 days of formation, LLC owners can make this election by filing Form 2553 with the IRS. This allows LLC owners to benefit from the tax advantages of an S-Corporation while maintaining the flexibility and simplicity of an LLC structure.

Each business structure has its advantages and disadvantages, so it's essential to weigh your options carefully based on your individual circumstances and long-term goals.

When I initially began my journey, I believed that forming an LLC was the right choice for me, so that's the path I pursued. At the time I was unemployed and focused on solopreneurship. However, as I gradually accumulated more projects and increased my earnings, I found it beneficial to convert my LLC to an S-Corporation after the first year. Despite the additional administrative tasks, such as quarterly payroll and tax filings, transitioning to an S-Corporation provided substantial tax savings for me. If you're exploring freelancing and side consulting while maintaining a full-time job, starting with a sole proprietorship may be a better option for you. However, it is best to speak with a CPA or lawyer regarding what makes the most sense for you and your situation.

Important Changes in 2024

In 2021, Congress passed the Corporate Transparency Act and this law creates a new beneficial ownership information (BOI) reporting requirement as part of the U.S. government’s efforts to make it harder for bad actors to hide or benefit from their ill-gotten gains through shell companies or other opaque ownership structures. FinCEN launched the BOI e-filing website for reporting beneficial ownership information on January 1, 2024. https://boiefiling.fincen.gov

• A reporting company created or registered to do business before January 1, 2024, will have until January 1, 2025, to file its initial BOI report.

• A reporting company created or registered in 2024 will have 90 calendar days to file after receiving actual or public notice that its creation or registration is effective.

• A reporting company created or registered on or after January 1, 2025, will have 30 calendar days to file after receiving actual or public notice that its creation or registration is effective.

Thanks for reading! Next week, I will share a list of online platforms connecting expert scientists with businesses in need of specialized consulting services. It’s a great way to supplement your income but also an excellent idea for expanding your horizons into consulting and solopreneurship.

PS: If you liked this post, please share it with a friend, and don’t forget to subscribe to get the weekly newsletter delivered directly to your inbox.

Until next week,

Bonnie