What Business Enitity Should I Form in Virginia?
Full Question:
Answer:
If you wish to have a professional entity, there are professional corporations and professional limited liability companies. They are typically formed to protect individual members from personal liability for the negligent acts of other members or employees not under their direct control. They are often formed by professional businesses such as lawyers, accountants, etc., who are subject to malpractice claims.
There are various options available for choice of a corporate entity. The downside of incorporation is that the income of the corporation is taxed separately—and the owner gets his or her share only after the corporate tax has been deducted. The owner also then owes additional taxes on his or her earnings. Thus double taxation is involved.
An S corporation combines the limited liability of a corporation and the "pass-through" tax-treatment of a partnership. It is a business structure suited to small business owners who want the continuity and liability protection of a corporation but wish to be taxed as a sole proprietorship or partnership. S corporation status is appropriate for:
-Companies expecting start-up losses during the initial years of operation.
-Companies expecting start-up losses during the initial years of operation.
-Companies with no intent of going public in the future.
-Companies that do not expect to issue multiple classes of stock
-Companies that might be subject to the Alternative Minimum Tax.
-Owners who live in a state with no personal state income tax.
-Companies whose sales are less than $250,000 per year (as a rough guideline).
-Shareholders who earn less than maximum amount subject to Social Security tax --Shareholders who actively participate in the business.
-Companies that plan to distribute most of its annual profits to its shareholders.
Forming a S corporation begins with a C corporation. An S corporation is essentially a C corporation that has elected to become an S corporation for tax treatnment purposes. The S corporation election form 2553 is filed with the Internal Revenue Service. Instead of being taxed at the corporate level, the income “passes through” to the individual shareholders. This is the same basic "pass-through" treatment afforded partnerships and LLCs. Any income or loss generated by the S corporation is reported on the individual tax returns of the shareholders, rather than being taxed at the corporate level. Thus, the S corporation election is a popular choice for most small businesses. In this case the corporation cannot have more than 75 shareholders. There are restrictions regarding who may and may not own stock. Generally, non-resident aliens, trusts, other S corporations, C corporations (with few exceptions) may not own stock. An S corporation must have a maximum of 75 shareholders who are individuals (though certain types of trusts and estates may qualify). Once a corporation makes the Subchapter S election to be an S corporation, profits and losses are passed through the corporation and are reported on the individual tax returns of the respective shareholders of the S corporation. Thus, the key distinction of the S corporation is that profits and losses are not taxed at the corporate/business level like they would be if the corporation remained as a C corporation.
REQUIREMENTS/FILINGS
An S corporation follows the same state formalities as does a C corporation, such as filing articles of incorporation and paying state fees.
S corporations must make a special tax election under sub-chapter S of the Internal Revenue Code by filing IRS Form 2553. The election, which is made by filing form IRS 2553, must be made by March 15 in order for the election to take effect that year. If the election is made after March 15 but within 75 days of the incorporation date, the election will be effective for the next calendar year. If the S corporation is not a calendar-year taxpayer, the election must be made within 75 days of the beginning of the corporation’s tax year. Some states also require a filing of S corporation election.
The S corporation must complete and file IRS Form 1120s to report its annual income to the IRS each year.
If your corporation has a tax-year end date other than December 31, you must file for permission from the IRS.
SHAREHOLDERS
ALL shareholders of the corporation must be U.S. Citizens or have U.S. Residency Status. If, for any reason, shares are somehow sold or transferred (even if by will, divorce, or other means) to a shareholder who is a foreign national, the corporation will lose its S corporation status and be treated as a C corporation. S corporations cannot be owned by C corporations, other S corporations, many trusts, LLCs, or partnerships. Estates or trusts may be allowed as stockholders, but corporate or foreign investors are not allowed. This includes other businesses that are not corporations, such as partnerships or sole proprietorships. This provision, therefore, excludes corporate subsidiaries from claiming S corporation status.
75 Shareholders Maximum.
S corporations may have only one class of stock. This means that with the purchase of stock must come the same economic rights, such as receiving dividends or compensation in the event of liquidation at the same time and in the same amount per share as all other shareholders. Voting rights may differ amongst the shareholders without being considered a sign of the possession of different classes of stock.
An S corporation that loses its status as such may no re-elect S corporation status for a minimum of five years.
INCOME
An S corporation’s passive income level must not exceed the 25% of gross receipts over a consecutive three year period limit.
ADVANTAGES
For certain individuals, the pass-through treatment of income will result in lower tax liability than taxation at the corporate level. Stock may be issued to the public as long as the 75 shareholders limit is not exceeded. S corporations enjoy the limited liability attached to corporations. The corporation can pay the owner a reasonably small salary (which is subject to Social Security and Medicare tax). Then, the corporation can pay a relatively large distribution of profits (on the Schedule K-1 form – which is not subject to Social Security and Medicare tax). This may save the Social Security/Medicare tax on a sizable chunk of income. It is relatively easy to transfer ownership and add new owners.
DISADVANTAGES
Individuals who benefit from the lower tax rate paid by corporations should not apply for S corporation status. S corporation status imposes limitations on ownership of company stock, such as foreign ownership. An S corporation may only offer one class of stock and an S corporation is limited to a maximum of 75 shareholders. If you plan to invest corporate profits back into the corporation and will only draw a nominal salary, you may still have tax liability on the balance of the dividends that you reinvested in the corporation. When a shareholder of an S corporation is sued in a personal (not a business) lawsuit, the shares of stock are assets that may be seized. Separate tax returns must be filed and there is a possibility of double taxation at the shareholder and corporate levels.
LLC vs. S-CORPORATIONS
An advantage of an LLC is that the formation and ownership requirements are less rigid. Usually, an S-Corporation can issue only one class of stock, while a LLC may offer a variety of classes. The LLC also doesn't limit the number of shareholders to seventy-five or less, and doesn't prohibit non-resident aliens from possessing ownership in the company. A LLC has no restrictions against shareholders being other corporations, LLCs, or partnerships, as exists for an S-Corporation.
The LLC also is more flexible regarding management of the company. The LLC can be “member-managed,” meaning that it would be managed directly by the shareholders. Alternatively, the owners of the LLC can agree to have the business “manager-managed,” meaning that the management can be structured and delegated from the owners to managers.
One of the main reasons an S-corp may be preferable is the ease with which the stock can be sold or otherwise transferred. A sale of an ownership interest in an LLC must meet certain requirements, but there are very few restrictions on selling s-Corporation stock. Another advantage to an S-Corp may be lower state filing fees. Also, the pass-through tax advantage may be less beneficial to businesses that are small enough to take advantage of the 15% and 25% tax rates.For further discussion, please see the information at the following links:
http://www.irs.gov/businesses/small/article/0,,id=98263,00.html
http://www.irs.gov/businesses/small/article/0,,id=99903,00.html
http://www.sba.gov/smallbusinessplanner/start/chooseastructure/index.html
Please see the follwoing VA statutes to determine applicability:
"Professional business entity" means any entity as
defined in § 13.1-603 that is duly licensed or otherwise
legally authorized under the laws of the Commonwealth or the
laws of the jurisdiction under whose laws the entity is
formed to render the same professional service as that for
which a professional corporation or professional limited
liability company may be organized, including, but not
limited to, (i) a professional limited liability company as
defined in § 13.1-1102, (ii) a professional corporation
as defined in this subsection, or (iii) a partnership that
is registered as a registered limited liability partnership
registered under § 50-73.132, all of the partners of
which are duly licensed or otherwise legally authorized to
render the same professional services as those for which the
partnership was organized.
"Professional corporation" means a corporation whose
articles of incorporation set forth a sole and specific
purpose permitted by this chapter and that is either (i)
organized under this chapter for the sole and specific
purpose of rendering professional service other than that of
architects, professional engineers or land surveyors, or
using a title other than that of certified landscape
architects or certified interior designers and, except as
expressly otherwise permitted by this chapter, that has as
its shareholders or members only individuals or professional
business entities that are duly licensed or otherwise
legally authorized to render the same professional service
as the corporation, including the trustees of an eligible
employee stock ownership plan or (ii) organized under this
chapter for the sole and specific purpose of rendering the
professional services of architects, professional engineers
or land surveyors, or using the title of certified landscape
architects or certified interior designers, or any
combination thereof, and at least two-thirds of whose shares
are held by persons duly licensed within the Commonwealth to
perform the services of an architect, professional engineer
or land surveyor, including the trustees of an eligible
employee stock ownership plan, or by persons legally
authorized within the Commonwealth to use the title of
certified landscape architect or certified interior
designer; or (iii) organized under this chapter or under
Chapter 10 (§ 13.1-801 et seq.) of this title for the
sole and specific purpose of rendering the professional
services of one or more practitioners of the healing arts,
licensed under the provisions of Chapter 29 (§ 54.1-2900
et seq.) of Title 54.1, or one or more nurse practitioners,
licensed under Chapter 29 (§ 54.1-2900 et seq.) of
Title 54.1, or one or more optometrists licensed under the
provisions of Chapter 32 (§ 54.1-3200 et seq.) of
Title 54.1, or one or more physical therapists and physical
therapist assistants licensed under the provisions of
Chapter 34.1 (§ 54.1-3473 et seq.) of Title 54.1, or one
or more practitioners of the behavioral science professions,
licensed under the provisions of Chapter 35 (§ 54.1-3500
et seq.), 36 (§ 54.1-3600 et seq.) or 37
(§ 54.1-3700 et seq.) of Title 54.1, or one or more
practitioners of audiology or speech pathology, licensed
under the provisions of Chapter 26 (§ 54.1-2600 et seq.)
of Title 54.1, or one or more clinical nurse specialists who
render mental health services licensed under Chapter 30
(§ 54.1-3000 et seq.) of Title 54.1 and registered with
the Board of Nursing, or any combination of practitioners of
the healing arts, optometry, physical therapy, the
behavioral science professions, and audiology or speech
pathology, and all of whose shares are held by or all of
whose members are individuals or professional business
entities duly licensed or otherwise legally authorized to
perform the services of a practitioner of the healing arts,
nurse practitioners, optometry, physical therapy, the
behavioral science professions, audiology or speech
pathology or of a clinical nurse specialist who renders
mental health services, including the trustees of an
eligible employee stock ownership plan; however, nothing
herein shall be construed so as to allow any member of the
healing arts, optometry, physical therapy, the behavioral
science professions, audiology or speech pathology or a
nurse practitioner or clinical nurse specialist to conduct
his practice in a manner contrary to the standards of ethics
of his branch of the healing arts, optometry, physical
therapy, the behavioral science professions, audiology or
speech pathology, or nursing, as the case may be.
"Professional service" means any type of personal
service to the public that requires as a condition precedent
to the rendering of such service or use of such title the
obtaining of a license, certification, or other legal
authorization and shall be limited to the personal services
rendered by pharmacists, optometrists, physical therapists
and physical therapist assistants, practitioners of the
healing arts, nurse practitioners, practitioners of the
behavioral science professions, veterinarians, surgeons,
dentists, architects, professional engineers, land
surveyors, certified landscape architects, certified
interior designers, public accountants, certified public
accountants, attorneys-at-law, insurance consultants,
audiologists or speech pathologists, and clinical nurse
specialists. For the purposes of this chapter, the following
shall be deemed to be rendering the same professional
service:
1. Architects, professional engineers, and land surveyors;
and
2. Practitioners of the healing arts, licensed under the
provisions of Chapter 29 (§ 54.1-2900 et seq.) of
Title 54.1; nurse practitioners, licensed under the
provisions of Chapter 29 (§ 54.1-2900 et seq.) of
Title 54.1; optometrists, licensed under the provisions of
Chapter 32 (§ 54.1-3200 et seq.) of Title 54.1; physical
therapists and physical therapist assistants, licensed under
the provisions of Chapter 34.1 (§ 54.1-3473 et seq.) of
Title 54.1; practitioners of the behavioral science
professions, licensed under the provisions of Chapters 35
(§ 54.1-3500 et seq.), 36 (§ 54.1-3600 et seq.),
and 37 (§ 54.1-3700 et seq.) of Title 54.1; and one or
more clinical nurse specialists who render mental health
services, licensed under Chapter 30 (§ 54.1-3000 et
seq.) of Title 54.1 and are registered with the Board of
Nursing.
B. Persons who practice the healing art of performing
professional clinical laboratory services within a hospital
pathology laboratory shall be legally authorized to do so
for purposes of this chapter if such persons (i) hold a
doctorate degree in the biological sciences or a board
certification in the clinical laboratory sciences and (ii)
are tenured faculty members of an accredited medical college
or university that is an "educational institution" within
the meaning of § 23-14.
§ 13.1-544. Who may organize and become shareholder. —
A. An individual or group of individuals (i) duly licensed or otherwise
legally authorized to render the same professional services other than
those of architects, professional engineers or land surveyors, or to use
a title other than those of certified landscape architects or certified
interior designers, of which at least one is duly licensed or otherwise
legally authorized to render such professional services within the
Commonwealth, or (ii) complying with the provisions of § 13.1-549 and
duly licensed to render within the Commonwealth the professional services
of architects, professional engineers or land surveyors, or legally
authorized to use within the Commonwealth the title of certified
landscape architects or certified interior designers, or any combination
thereof, may organize a professional corporation for pecuniary profit
under the provisions of Chapter 9 (§ 13.1-601 et seq.) of this title or
organize a professional corporation as a nonstock corporation under the
provisions of Chapter 10 (§ 13.1-801 et seq.) of this title, for the sole
and specific purpose of rendering the same and specific professional
service, subject to any laws, not inconsistent with the provisions of
this chapter, which are applicable to the practice of that profession in
the corporate form.
B. An eligible employee stock ownership plan or any individual or group
of individuals described in clause (i) or (ii) of subsection A may become
a shareholder or shareholders of a professional corporation for pecuniary
profit under the provisions of Chapter 9 (§ 13.1-601 et seq.) of this
title, for the sole and specific purpose of rendering the same and
specific professional service, subject to any laws, not inconsistent with
the provisions of this chapter, that are applicable to the practice of
that profession in the corporate form.
C. Any individual or group of individuals described in clause (i) or
(ii) of subsection A may become a member or members of a professional
corporation organized as a nonstock corporation under the provisions of
Chapter 10 (§ 13.1-801 et seq.) of this title for the sole and specific
purpose of rendering such professional services, subject to any laws, not
inconsistent with the provisions of this chapter, that are applicable to
the practice of that profession in the corporate form.
§ 13.1-546. How corporation may render professional services;
nonprofessional employees and officers; organizers and shareholders need
not be employees, etc. —
No corporation organized and incorporated under this chapter may render
professional services except through its officers, employees, independent
contractors, and agents who are duly licensed or otherwise legally
authorized to render such professional services, and only shareholders,
officers, employees, independent contractors, and agents licensed or
otherwise legally qualified by this Commonwealth may perform the
professional service in Virginia; provided, however, this provision shall
not be interpreted to preclude clerks, secretaries, bookkeepers,
technicians and other assistants who are not usually and ordinarily
considered by custom and practice to be rendering professional service to
the public for which a license or other legal authorization is required
from acting as employees of a professional corporation and performing
their usual duties or from acting as officers of a professional
corporation; and provided further that nothing contained in this
chapter shall be interpreted to require that the right of an individual to be a
shareholder of a corporation organized under this chapter, or to organize
such a corporation, is dependent upon the present or future existence of
an employment relationship between him and such corporation, or his
present or future active participation in any capacity in the production
of the income of such corporation or in the performance of the services
rendered by such corporations.