Decide On The Form Of Organization
It is necessary to decide what
form of organization you will use before opening
the business.
Most small businesses operate as
a sole proprietorship. This is the
simplest form of organization with the greatest
freedom from regulation and paper work.
Its chief disadvantages are unlimited personal
liability for debts of the business and the fact
that the business terminates with death of owner.
In a partnership (like a sole proprietorship except
two of more persons are involved), the liability
for the firm's debts is also unlimited.
Death of a partner terminates the business and
any one of the partners can commit the firm to
obligations, which the other partner may have
to pay out of his own pocket.
A corporation has the advantage
of limiting personal liability to the amount owners
have for their shares of stock (unless creditors
require personal guarantee from stockholders).
Its continuity is unaffected by death or transfer
of shares by any of the owners. Also, ownership
may be widely distributed to many stockholders,
thus increasing the possibility of raising capital.
Within certain limits, owners as officers or employees
may participate, free of income taxes, in fringe
benefit programs, such as pension, group life
and health insurance plans. Major disadvantages
of the corporate form of organization are that
it requires more record keeping, it is a more
costly form of organization, and there can be
a double taxation on profits as dividends are
dispersed.
An S Corporation is a special
type of corporation, which receives different
tax treatment. If a corporation qualifies for
ìSî status from the Internal Revenue
Service, it is taxed like a partnership whereby
corporate income ìflows throughî
to shareholders and is taxed at individual rates.
The corporation itself is not taxed, thus
avoiding double taxation. In order to be an ìSî
corporation, certain requirements must be met.
First, you may have no more than 75 shareholders.
These shareholders are limited to individuals,
estates, and certain trusts. Corporations or foreigners
cannot be shareholders. Finally, there
can only be one class of stock. The ìSî
Corporation offers the limited liability benefits
of a corporation with the simpler tax structure
of a partnership.
In order to overcome some of the
ìSî Corporation restrictions, in
July 1, 1991 the Virginia General Assembly adopted
the Limited Liability Company Act. Limited
liability corporations provide the same advantages
as the ìSî corporation but also provides
greater flexibility in ownership. Specifically,
it eliminates restrictions regarding
- the number of shareholders,
- the type of shareholders, and
- the type of ownership interests that are
found with the ìSî Corporation.
Now, LLCs are also available to professionals
and even existing corporations and partnerships
can adopt the LLC forum through a simple merger
procedure. Two important limitations should be
noted about LLCs. First, an LLC may not provide
continuity for life and dissolution problems may
arise. Under Virginia law, an LLC automatically
dissolves upon death, withdrawal, or bankruptcy
of any member unless the remaining members unanimously
elect to continue the LLC. Second, activities
by an LLC outside the state could create the general
partnership liability for its members depending
on the host stateís laws regarding LLCs.
Other state laws may also not recognize the tax
benefits of an LLC and disallow the pass-through
tax strategy.
In summary, you should carefully
weigh the advantages and disadvantages of each
legal structure taking into account your own specific
situation. The information provided in this document
should only serve as a starting point for your
decision process. Consult
an attorney for an in-depth analysis of your
situation.
The attorney will be able to help you identify
specific strengths and limitations as they apply
to your business.
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