A Sole Proprietorship is the most common form of business organization.
In general, sole proprietorships in Virginia can be formed with no formalities and it offers complete control to the owner. However, it will generally be necessary to obtain one or more local business licenses from the cities or counties in which you operate and, in some cases, state licenses as well. Additionally, there may be a requirement to register the business with the Clerk of the Court for the city of county in which you operate if your are conducting business under a fictitious name (Doing Business As (DBA)).
It is any unincorporated business owned entirely by one individual. Sole Proprietors can operate any kind of business. It must be a business, not an investment or hobby. It can be full or part-time work. This includes operating, among others, a:
- Shop or retail trade business,
- Home-based business and/or a
- One-person consulting firm
Generally, sole proprietors file Schedule C or C-EZ, Profits or Loss from Business, with their Form 1040. Sole proprietor farmers file Schedule F, Profit or Loss from Farming. The net business income or loss is combined with other income and deductions and is taxed at individual rates on the personal tax return.
Sole proprietors must also pay Self-Employment Tax on the net income reported on the Schedule C or F and up to one-half of the Self-Employment Tax can be deducted on the 1040.
Sole proprietors do not have taxes withheld from their business income, so a business owner will generally need to make quarterly estimated tax payments if the company is expected to make a profit.
Partnerships, LPs and LLPs
A Partnership is the relationship existing between two or more persons who join together to carry on a trade or a business.
Each contributes money, property, labor or skill and expects to share in the profits and losses of the business.
As a rule, General Partnerships (GP) in Virginia can be formed with no formalities, although it is highly advisable to have a written partnership agreement in place. This agreement should spell out, in considerable detail, such matters as:
- How much and what kind of property will each individual contribute to the partnership?
- What value will be placed on the contributed property?
- How will the profits and losses be divided among the partners?
- How will the gain or loss be allocated for tax purposes or property contributed to the partnership by one or more of the partners, where such property has a tax basis significantly greater or less than its agreed value?
- When and how will profits be withdrawn from the partnership?
- How will certain partners be compensated for making capital available to the partnership?
- How will changes in ownership and/or interests in the partnership be handled?
- When and how will the partnership terminate its existence?
- How will the assets and liabilities of the partnership be handled when the partnership is terminated?
A partnership does not pay any income tax at the partnership level. Partnerships file Form 1065, U.S. Return of Partnership Income, to report income and expenses. This is an information return. The partnership passes the information to the individual partners on Schedule K-1, Partner’s Share of Income, Credits and Deductions. Partnerships are often referred to as pass-through or flow-through entities for this reason.
Partners are not employees and so taxes are not withheld from any distributions. Like sole proprietors, partners generally need to make quarterly estimated tax payments if the expect to make a profit.
A Limited Partnership (LP), in which there is at least one general partner who is liable for partnership debts, and at least one limited partner, who is not liable for partnership debts, may also be formed under Virginia law. Unlike a General Partnership, a Limited Partnership must always have a written partnership agreement and must file a “Certificate of Limited Partnership” with the State Corporation Commission.
Limited Partners are subject to self-employment tax only on guaranteed payments, such as professional fees for services rendered.
Limited Liability Partnerships
A Limited Liability Partnership (LLP) is a new form of partnership permitted in Virginia. Like a Limited Liability Company, a Limited Liability Partnership provides limited liability for its owners while retaining the tax advantages of a partnership. However, unlike a Limited Liability Company an LLP typically operates like a regular partnership and is not required to file Articles of Organization. For more information about LLP registration and the financial responsibility and requirements, contact the State Corporation Commission or speak with your attorney.
Limited Liability Company
Limited liability companies are popular because, similar to corporations, owners generally have limited personal liability for debts and actions of the company. Other features are more like a partnership, providing management flexibility along with the benefits of pass-through taxation. Owners of an LLC are called members. Since most states do not restrict ownership, members may include individuals, corporations, other LLCs and foreign entities. Most states also permit “single member” LLCs, those having only one owner.
To form an LLC, a member must file Articles of Organization with the State Corporation Commission. Foreign LLCs, those formed under the laws of another state must obtain a certificate of authority in order to do business in the Commonwealth.
For additional information on the kinds of tax returns to file, how to handle employment taxes and other possible pitfalls, refer to IRS Publication 3042, Tax Issues for Limited Liability Companies.
Corporations (C Corp)
A corporate structure acts as its own entity under the law. Therefore, unless the owners "pierce the corporate shield" a corporation can protect the personal assets of the owners. Corporations are more complex than most other ownership structures. It requires complying with more regulations and tax requirements and usually requires more tax preparation services then either a sole proprietorship or partnership.
To form a corporation in the Commonwealth of Virginia, Articles of Incorporation must be filed with the State Corporation Commission and fees must be paid to register the corporation as well as for the amount of stock that will be issued. A foreign corporation, one formed under the laws of another state or foreign country must also obtain a certificate or authority to operate before it may legally conduct business in the Commonwealth. There also is a requirement to file annually with the Commission and failure to do so in a timely manner could result in the suspension or revocation of the corporation’s charter.
When a corporation is formed, a separate tax-paying entity is formed as well. Unlike sole proprietors and partnerships, income earned by the corporation is taxed at the corporate level using corporate tax rates. Regular corporations are called “C” corporations because Subchapter “C” of Chapter 1 of the IRS Code is where you find general tax rules affecting corporations and their shareholders.
Subchapter S Corporation
An S Corporation (S Corp) is a variation of the standard corporation, considered simpler than a C Corp with fewer tax implications.
This entity has the same structure as a standard corporation in that it is chartered under state law and is separate from its shareholders and officers. There is general limited liability for corporate shareholders. As with a corporation, there is a requirement to file Articles of Incorporation with the State Corporation Commission.
S corporations are usually taxed somewhat like a partnership in that the income, losses and tax credits flow-through to the owners who report such information on their individual tax returns. This entity files Form 2553, Election by a Small Business Corporation, to be treated differently for tax purposes.
Generally, an S corporation is exempt from federal income tax other than tax on certain capital gains and passive income.
An S Corporation files Form 1120S, U.S. Corporation Income Tax Return for an S Corporation. The income flows-through to be reported on the shareholders individual returns. Schedule K-1, Shareholder’s Share of Income, Credits and Deductions, is completed along with Form 1120S. Shareholders must pay tax on their share of corporate income regardless of whether it is actually distributed.