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Frequently Asked Questions Regarding Organization
of Your Small Business
1.
What Type of Business Entity Should I Choose for My New Small Business?
Virginia
recognizes several types of business entities. The form that you
should choose depends on many factors. These include, among other
factors, business purpose, desired ownership structure, desired
management structure, control issues, duration of business, liabilities
inherent in the business, capital and debt needs of the business,
liquidity and ease of transferability of ownership interests, transferability
of assets, administrative and reporting burdens, and the cost of
business. In addition, federal income tax considerations are involved
including income taxation at the entity and owner levels, comparative
tax rates, desired allocation of the income tax attributes to owners,
desired distributions to owners, whether the business is a passive
activity for the owners, employee benefits, self-employment tax,
and other tax burdens.
Since both
legal and financial considerations are involved, you will want to
consult both your attorney and accountant or financial advisor in
making this choice.
2.
Can You Provide a Comparison of the Different Types of Business
Structures in Virginia?
The most
commonly used entities for organizing a small business are the following:
a. Sole
Proprietorship - an unincorporated business that is owned and
operated by one person. That person receives all profits and is
personally liable for all losses. The sole proprietor has complete
control over the affairs of the business. All assets and interests
of the owner in his business are freely transferable.
The sole
proprietor and his business are one and the same for income tax
purposes. Therefore, the profits and losses of the business are
reported on the owner's personal income tax return. The sole proprietor
must pay self-employment taxes with respect to his or her taxable
income as well as withholding and social security taxes for any
of his or her employees.
One advantage
of the sole proprietorship is that there are no formalities required
under the law to organize the business. It is not even necessary
to register the business with the Virginia State Corporation Commission
upon its formation. But one major disadvantage is that since there
is no separate business entity apart from its owner, the sole
owner is subject to unlimited liability.
b. General Partnership - a relationship existing between two or
more persons who join together to carry on a trade or business
for profit. Each partner contributes money, property, labor, skills,
etc., and agrees to share in the profits and losses. The Virginia
Revised Uniform Partnership Act governs general partnerships in
Virginia.
Virginia
law does not require a written partnership agreement. But a written
agreement is advisable. Although a general partnership is not
required to register with the Virginia State Corporation Commission
upon its formation, it is authorized to file numerous optional
statements with the SCC such as statements of authority and statements
of dissolution.
A general
partnership is liable for its own debts and any wrongful action
of its partners to the extent of partnership assets. In general,
partners are jointly and severally liable for the debts and obligations
of the partnership. Partners can agree to restrict transfers of
partnership interests or place conditions on such transfers.
A partnership
is generally not taxed as a separate entity for income tax purposes
although it can elect to be taxed as a corporate entity. Unless
the general partnership elects to be taxed as a corporate entity,
the partners pay income taxes based on their allocable shares
of the profits of the partnership. Partners pay self-employment
taxes and also pay withholding and social security taxes for any
employees of the partnership.
Some advantages
of the general partnership form are the income tax treatment and
the flexibility the partners have in deciding how to run the company.
The primary disadvantage is that the partners are generally liable
for the debts of the partnership
Limited
Partnership - partnership form whereby general partners maintain
control over the management of the company and limited partners
invest money or property and are entitled to share in the profits.
Limited partners do not participate actively in the company but
are generally given the right to vote on certain major decisions.
General partners are liable for all debts, and limited partners
are liable only to the extent of their investment. A Virginia
limited partnership is created by filing a Certificate of Limited
Partnership with the State Corporation Commission (SCC).
Like general
partnerships, limited partnerships are not required to have written
partnership agreements but most do. The Virginia Revised Uniform
Limited Partnership Act governs limited partnerships. Tax laws
relating to general partnerships also apply to limited partnerships.
The limited
partnership is a good choice to allow passive investors to participate.
c. Corporation
- an entity with legal existence separate and apart from its individual
owners. Corporations are classified as stock or nonstock.
A stock corporation is usually organized for profit and
is authorized to issue shares to raise capital;
Nonstock corporations are not authorized to issue shares
and are usually organized for purposes other than to make profit;
Professional Corporations consist of individuals authorized
to perform certain professional services in Virginia. These include
pharmacists, optometrists, physical therapists, certain medical
professionals, architects, engineers, surveyors, accountants,
attorneys, insurance consultants, among others.
Every corporation must register with the Virginia SCC before beginning
its operations in Virginia by filing Articles of Incorporation.
Corporations are governed by Title 13.1 of the Code of Virginia.
A corporation
can elect to be an S corporation for federal income tax purposes.
When it makes this election, it will not be taxed as a corporation.
Rather, the shareholders will be taxed as though they were partners
in a partnership such that items of income, gain, loss, deduction,
and credit are allocated in proportion to their stock ownership.
If the corporation does not elect S corporation status, then it
will be classified as a C corporation and taxed on its taxable
income. In addition, the shareholders are taxed on dividends they
receive.
A major
advantage of the corporate entity is that the liability of the
shareholders is limited but they have the ability to participate
in the management of the company by election of directors and
the right to vote on certain major issues. Corporations are a
commonly accepted business entity with a basic statutory framework
supported by a significant body of case law. On the other hand,
there are some major tax disadvantages to the C corporation structure.
And, even if a corporation elects S corporation status, there
are burdensome and complex statutory restrictions applicable to
the structure and operation of S corporations.
d. Limited
Liability Company - an unincorporated association of one or more
members. The liability of the members is limited like a corporation
and the company may be taxed as either a corporation or a partnership.
Limited liability companies are governed by the Virginia Limited
Liability Company Act.
Professional limited liability companies are organized to perform
professional services enumerated in the Code of Virginia in the
LLC form.
Every LLC
must register with the SCC by filing Articles of Organization.
Typically, members of the LLC enter into an operating agreement
that sets forth how the company will be operated.
One advantage
of this form of entity is that like a corporation, the members'
liability is limited. In addition, the company may elect to be
treated, for income tax purposes, as a partnership. Furthermore,
there are no restrictions on the number of members or type or
character of members as there is with S corporations. There is
great flexibility and few formalities.
3. What Steps Should I Take Before Starting
My New Business in Virginia?
In addition
to the consideration of what entity you should choose for your new
business and making sure you register properly with the Virginia
State Corporation Commission (SCC), it is important to take the
following important steps before you begin your operations.
a. Assumed/Fictitious
Name - make sure you comply with all filing and registration requirements
if you plan to use an assumed or fictitious name (a name other
than the legal name of the business);
b. Registration With SCC Divisions - in addition to registration
with the SCC, it may be necessary to register with one or more
of the SCC divisions depending on the type of business you will
operate;
c. Federal Employer Identification Number (EIN) - you will need
to obtain a federal EIN in most cases;
d. Virginia Employment Commission - you may need to register with
the Virginia Employment Commission and complete the Report to
Determine Liability for State Unemployment Tax;
e. Virginia Department of Taxation -- you will need to also register
with the Department of Taxation;
f. Local License Tax -- you must contact your county or city Commissioner
of the Revenue to determine which licenses you will need and you
should check with local zoning or planning departments to verify
that you can operate your business at your desired site;
g. Insurance - you need to consider whether you will be required
to carry workers compensation insurance and whether any other
type of insurance is advisable including liability, fire, auto,
employee health and life, fidelity, business interruption, theft,
and key person insurance;
h. State Agencies - you should also determine whether you will
need licenses or permits from any applicable state agencies.
The Virginia State Corporation Commission website also contains
information that is helpful to individuals starting a new business
in Virginia.
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Co. presents the information in this website as a service to our
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information contained in these web pages is not legal advice. The
information presented on these pages may not be applicable to your
particular legal situation. Please consult with a lawyer before
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