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As a business owner, the law is your sword and shield when properly engaged.  This section explores:
Legal Entities > Intellectual Property > Employment Related Law > Contracts

Legal Entities

Sole Proprietorship

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.

General Partnerships

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.

Limited Partnerships

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.

Intellectual Property

Copyrights

A copyright is a form of protection provided by the laws of the United States through the Library of Congress to authors of “original works of authorship”, including literary, dramatic, musical, artistic and certain other intellectual works.  This protection is available to both published and unpublished works.

To find out more information about this form of protection please visit:

Trademarks

A trademark is a word, phrase, symbol, design or a combination thereof, that identifies and distinguishes the source of goods from one party from those of others.  The US Patent and Trademark Office reviews trademark applications and determines if they meet the necessary federal standards for registration.

Patents

A patent is a form of intellectual property that gives its owner the legal right to exclude others from making, using, or selling an invention for a limited period of years in exchange for publishing an enabling public disclosure of the invention.

In the language of the statute, any person who “invents or discovers any new and useful process, machine, manufacture, or composition of matter, or any new and useful improvement thereof, may obtain a patent,” subject to the conditions and requirements of the law. 

The United States Patent and Trademark Office (uspto.gov) provides great information, including the ability to search existing patents. 

Trade Secrets

Trade secrets are a type of intellectual property that comprise formulas, practices, processes, designs, instruments, patterns, or compilations of information that have inherent economic value because they are not generally known or readily ascertainable by others, and which the owner takes reasonable measures to keep secret. Such measures include confidentiality agreements and restricted access to information.

Confidentiality and Non-Compete Agreements

Confidentiality agreements (CAs) or non-disclosure agreements (NDAs) are common in business. When two parties are disclosing to each other a mutual non-disclosure agreement (MNDA) may be used. These agreements can be useful, but be careful about definitions relating to what is considered confidential and how confidential information is shared. 

Non-compete agreements are also common when trade secrets or proprietary processes are involved. In contract law, a non-compete clause, or covenant not to compete, is a clause under which one party agrees not to enter into or start a similar profession or trade in competition against another party. Some courts refer to these as “restrictive covenants”. Restrictions on terms for these agreements are addressed in state laws. In Virginia, if any aspect of the restriction is deemed unreasonable, the entire clause will be stricken.

Joint Development Agreements

When two companies work together to test or develop intellectual property (IP), a joint development agreement (JDA) should be in place prior to sharing IP. These are accompanied by MNDAs. JDAs should have a clear definition of who owns any resulting IP, and what happens with equipment, material, or information shared upon completion or termination of the agreement. 

When a small company partners with a much larger company in a JDA, small companies often feel pressure to give restrictive rights to the IP in exchange for the JDA. We warn against this and suggest speaking with an advisor during negotiation, and an attorney prior to signing any contracts. 

Employment Law

Employee vs. Contractor

The lines between employee and independent contractor are often blurred by employers. The IRS has devised a series of tests and guidelines to help measure and compare whether your worker is an employee or independent contractor. Treating ‘Independent Contractors’ like employees can result in fines and penalties.

 

Common Law Employees

 

A basic means of determining whether a worker is an employee is to apply the standard of: Every worker who performs services subject to the will and control of the employer, both as to the methods and results of the work (what is to be done and how it is to be done), is an employee. Although a simple test, it is vague and needs an instrument of measurement for clarification.

 

Independent Contractors

 

Independent contractors are those who practice an independent profession, trade or business in which they offer their services to the general public. An individual is treated as an independent contractor if the business that pays for the services only has the right to control or direct the final result of the work and not the means of accomplishing that result.

 

24 Factor Test

 

In order to aid employers in determining whether a worker is an employee beyond the Common Law Test, the IRS has established 24 Factors to consult for further clarification. The following chart is a comparison of the 24 factors based on employee attributes contrasted against those of an independent contractor. They can be found here: Employees vs. Contractor Factors.

Department of Labor

This guide, which is prepared by the US Department of Labor, describes the major statutes and regulations administered by the Department that affect businesses and workers.  It is designed mainly for those needing “hands-on” information to develop wage, benefit, safety and health and nondiscrimination policies for businesses.

Statutory and regulatory changes will occur over time, which may affect the information in this guide.  For the latest information on all laws check this site periodically.

Employee Handbook

As the business prepares to bring on additional personnel, one “must-do”  action is to put an employee handbook together.  It not only protects your business, it establishes a framework for getting the most out of employees while supporting them and being clear about policies and procedures. It can also serve to instill culture that carries through to business customers.

Many small business owners can experience trouble with local employment laws and regulations by not having such a governing document available for their employees.

While many business owners are somewhat overwhelmed at the prospect of assembling the contents of the handbook, the US Small Business Administration has an easy to understand briefing on the contents of the handbook and a downloadable template that business owners can utilize.

This template can be accessed through: 

Employment Agreements

Employment agreements can take many forms, depending on the job being performed. Standard employment agreements include: effective date, full or part-time, duties to be performed, benefits, payment policies, effective date and termination policies, dispute process, notification rules and applicable law. 

Restrictive covenants may include confidentiality agreements, non-compete agreements and a non-solicitation agreement (whereby the employee may not solicit customers from the business for their own purposes). 

More complex agreements that involve equity, such as in the case of executive compensation, will require several documents including adjustments to the company operating agreement. 

In any employment agreement, it is important to spell out expectations and rules for severability in advance to avoid conflict within the company should problems occur.

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.

Contracts

Seven essential elements must be present before a contract is binding: the offer, acceptance, mutual assent (also known as “meeting of the minds”), consideration, capacity, and legality.

Contracts for Goods and Services

When a contract is required to purchase goods, the goods may have restrictions of use. This may be for reasons relating to restricting market entry or concerns about danger or liability involved with use or manipulation of the goods. Such contracts should be carefully reviewed. The same holds true for service contracts. Liability, avoidance of financial injury, or protection of intellectual property are usually at the heart of these agreements. We recommend attorney review of any unclear or cumbersome clauses. 

Reseller or Distribution Agreements

Companies that rely on other businesses to distribute their goods should have reseller agreements in place. Typical clauses relate to: use and protecting the brand, representation of the products, promotions and pricing, restrictions on selling in third party marketplaces (such as Amazon) or to third parties not bound by the reseller agreement. 

Leases

Property and equipment leases are some of the most common contracts in business. The lessor is the owner, and the lessee is the entity paying for the right to use the property of the lessor. 

Key items to consider in leases are: term and term extensions, insurance for the property, liability restrictions on both parties, limits on rate increases, what happens if use of the property is inhibited, responsibilities for repairs and upkeep and termination. 

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