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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 S status from the Internal Revenue Service, it is taxed like a partnership whereby corporate income flows through to shareholders and is taxed at individual rates. The corporation itself is not taxed, thus avoiding double taxation. In order to be an S 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 S Corporation offers the limited liability benefits of a corporation with the simpler tax structure of a partnership.

In order to overcome some of the S 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 S 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 S 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 state's 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.
Last updated: 5/8/2013 2:48:45 PM