Should I Start an LLC for My Test Prep Business?

Starting a limited liability company (LLC) for your test prep business can provide several benefits.

Most importantly, an LLC structure offers limited liability to its owners, which can protect their personal assets from lawsuits and creditors.

For a test prep business, lawsuits can arise from things like using copyrighted test questions without a license, misrepresenting the SAT pass rate of the business’s ex-students, and customers injuring themselves on your premises.

LLCs are also affordable, highly flexible (from a tax point-of-view), and can make your test prep business seem more credible.

Recommended: Use Northwest to form an LLC for $29 (plus state fees).

Do I Need an LLC for a Test Prep Business?

LLCs are a simple and inexpensive way to protect your personal assets and save money on taxes.

You should form an LLC when there's any risk involved in your business and/or when your business could benefit from tax options and increased credibility.

LLC Benefits for a Test Prep Business

By starting an LLC for your test prep business, you can:

Protect your savings, car, and house with limited liability protection
Have more tax benefits and options
Increase your business’s credibility

Limited Liability Protection

LLCs provide limited liability protection. This means your personal assets (e.g., car, house, bank account) are protected in the event your business is sued or if it defaults on a debt.

Test prep businesses will benefit from liability protection because of the risk of being sued for false advertising, libel, and even personal injuries.

Example 1: One of the tutors at your test prep company is discovered to be using copyrighted test questions without the owner’s permission. This leads the owner to file a copyright infringement lawsuit against your business. In the following lawsuit, your personal assets would be protected by liability from being used by the court to meet any business obligations to pay damages.

Example 2: Another employee states to a client that your test prep company has a very high success rate in helping students pass their SATs. However, after the customer is unable to obtain the mark they were aiming for, they decide to sue your business for fraud. Limited liability would ensure that your personal assets are not used to compensate the customer.

Example 3: A student at your test prep company seriously injures themselves after accidentally shutting a heavy fire door on their fingers at your premises. Blaming your business for this injury, the child’s parent files a negligence lawsuit against you. In this instance, the court is precluded from going after your personal assets to satisfy any business requirement to pay damages.

An LLC will also protect your personal assets in the event of commercial bankruptcy or loan default.

To maintain your LLC's limited liability protection, you must maintain your LLC's corporate veil.

LLC Tax Benefits and Options for a Test Prep Business

LLCs, by default, are taxed as a pass-through entity, just like a sole proprietorship or partnership. This means that the business's net income passes through to the owner's individual tax return.

The business’s net income is then subject to income taxes (based on the owner's tax bracket) and self-employment taxes.

Sole proprietorships and partnerships are taxed in a similar way to LLCs, but they do not offer limited liability protection or other tax options.

S Corp Option for LLCs

An S corporation (S corp) is an IRS tax status that an LLC can elect. S corp status allows business owners to be treated as employees of the business (for tax purposes).

S corp tax status can reduce self-employment taxes and will allow business owners to contribute pre-tax dollars to 401k or health insurance premiums.

The S corp status requires that the business pay the employee-owner(s) a reasonable salary for the work they perform.

In addition, the business might need to spend more on accounting, bookkeeping, and payroll services. To offset these costs, you'd need to be saving about $2,000 a year on taxes.

We estimate that if a test prep business owner can pay themselves a reasonable salary and at least $10,000 in distributions each year, they could benefit from S corp status.

You can start an S corp when you form your LLC. Our How to Start an S Corp guide will lead you through the process.

Credibility and Consumer Trust

Test prep businesses rely on consumer trust. Credibility plays a key role in creating and maintaining any business.

Businesses gain consumer trust simply by forming an LLC.

A growing business can also benefit from the credibility of an LLC when applying for small business loans, grants, and credit.

Northwest will start an LLC for you for just $29 (plus state fees).

Get Started

How to Form an LLC

Forming an LLC is easy. There are two options for forming your LLC:

You can hire a professional LLC formation service to set up your LLC for a small fee
Or, you can choose your state from the list below to start an LLC yourself

Select Your State

For most new business owners, the best state to form an LLC in is the state where you live and where you plan to conduct your business.

Do LLCs Need Insurance?

All businesses need insurance to protect their business assets — even LLCs. This is because the limited liability protection from an LLC protects your personal assets, not your business assets.

All businesses, including your test prep company, are faced with unforeseeable circumstances that threaten your business’s assets. Insurance eliminates this risk for your company by protecting against any financial losses that can arise from these unexpected events like negligence or poor advice.

Common Situations Business Insurance May Cover for a Test Prep Business

Example 1: During a tutoring session, you accidentally knock a drink over, damaging your student’s laptop and mobile phone. Your general liability policy would cover the cost to repair or replace the devices.

Example 2: During a severe rainstorm, a student’s parent slips and falls on your tile floor. Even though you had a warning sign prominently displayed, you are being sued for their injuries. General liability insurance would cover legal representation and any damages awarded in the lawsuit.

Example 3: While at a client’s home for a private tutoring session, you knock over a valuable art piece. Your general liability policy would cover the cost of repairing or replacing the damaged art.

Other Types of Coverage Test Prep Businesses Need

While general liability is the most important type of insurance to have, there are several other forms of coverage you should be aware of. Below are some other types of insurance all test prep businesses should obtain.

Professional Liability Insurance

While you may consistently deliver the level of service agreed upon, things don’t always work out as expected. If a student underperforms on a test or you accidentally teach the curriculum incorrectly, the client may take legal action against you. Professional liability insurance will cover the cost of legal defense, as well as any resulting payout.

Commercial Property Insurance

If you own the building you and your team tutor out of, it is critical that your property is adequately insured in the event of a loss. A commercial property insurance policy provides coverage for your commercial building, and any business property kept onsite. Owners are encouraged to be thorough, including the replacement cost of business property and the cost of all building renovations, when determining coverage limits.

Workers’ Compensation Insurance

Workers’ compensation provides coverage for medical bills and lost wages if an employee is injured or falls ill while on the job. If a lawsuit occurs as a result of this injury, the policy would also cover related legal fees. While the requirements vary from state to state, business owners are required by law to carry this coverage for each of their employees.

Home-based Business Insurance

Business owners who operate out of their homes are encouraged to purchase this coverage. Since homeowners insurance often excludes business-related losses, a home-based business insurance policy is there to protect you, ensuring seamless coverage.

Commercial Auto Insurance

Many test prep companies offer a variety of services, including in-office tutoring and one-on-one tutoring in their clients’ homes. If this is the case, you may spend a good deal of time on the road, increasing your risk of an auto accident. If a loss occurs while on the job, coverage may be excluded from your personal auto policy. To ensure no gaps in coverage, business owners should purchase a commercial auto policy.

Each state mandates how much commercial auto insurance coverage is required. However, the minimum limits leave many business owners underinsured. Working with your insurance agent to determine proper coverage limits can help protect both you and your business.

Should I Start an LLC FAQ

Choosing the right business structure depends on your business’s unique circumstances and needs. However, unless your business is very low risk (like a hobby), an LLC is likely the better option.

Visit our LLC vs. Sole Proprietorship guide to learn more.

At a minimum, you’ll need general liability insurance and professional liability insurance.

Read our Business Insurance article for more info.

If you are thinking about opening a test prep business, startup costs are fairly minimal. This is possible with as little as $2,000, which could cover the expenses of designing a professional website, accumulating an inventory of test books, and business advertising.

Visit our How to Start a Test Prep Business guide to learn more about the costs of starting and maintaining this business.

Travel costs and website hosting are the primary ongoing expenses. If you have a separate office, you will also have to pay for rent and utilities.

Learn more about running a test prep business.

A test prep business charges clients for test prep lessons. Some test prep businesses may charge for individual lessons and group classes.

Learn more about starting a test prep business.

A test prep service helps prepare people for standardized tests like the ACT, SAT, MCAT, and LSAT. Test prep businesses can conduct lessons in an office, in a client’s home, or entirely online.

Net profits depend on client volume and overhead costs.

Learn more about starting a test prep business.