Of all the choices you will make in starting a business, one of the most important will be choosing the type of legal business structure for your company. This decision can affect the amount you pay in taxes, the ease or difficulty in selling shares or interests in your company, the corporate formalities that you will have to adhere to, continuity, and the protection of your personal assets from business debts and liabilities. This important decision should be made in consultation with an attorney and your certified public accountant.
In the State of Texas there are a number of business structures to choose from:
The Sole Proprietorship is the most common and simplest business structure. In a sole proprietorship a single individual conducts business without formally incorporating his or her business. A sole proprietorship can operate under an assumed name if the proper form has been filed in the County’s records. A sole proprietorship may use the terms “Company” or “Co.” in its assumed name but cannot use any term to imply incorporation such as “Inc.” or “LLC.” Because the sole proprietorship is not formally incorporated and entirely owned by one individual, its owner is personally liable for all financial obligations of the business. Sole proprietors generally need to make quarterly estimated tax payments, which include both income tax and self-employment taxes for Social Security and Medicare.
A corporation is a legal person which provides limited liability, centralization of management, perpetual duration, and ease of transferability of ownership interests that has formally filed incorporation records with the Secretary of State for the State of Texas. Owners of a corporation are referred to as “shareholders” while the people who manage the business and its affairs are called “directors.”
Texas State law requires that shareholders enter into an agreement which provides for the management of the corporation and process for eliminating and replacing directors.
There are two common types of corporations: a “C” corporation and an “S” corporation:
- “C” corporations are separately taxable entities which file a Form 1120 corporate tax return and pay taxes at the corporate level. As a result, “C” corporations face the possibility of double taxation if the corporate income is distributed to the shareholders as dividends. Tax on corporate income is paid first at a corporate level and again at the individual level on dividends.
- “S” corporations are pass-through entities; meaning they file an informational federal tax return (a Form 1120S), but no income tax is paid at the corporate level. Profits and/or losses of the corporation “pass through” the corporation and are reported on the shareholders’ personal tax returns. Any tax due is paid at the individual level by the owners.
Because of the often complex legal and tax implications, it is important to seek the advice of an attorney before choosing the best management structure for your corporation.
Limited Liability Corporation
A limited liability company (“LLC”) is a legal entity which enjoys the powers and benefits of both a corporation and a partnership. The owners of a LLC are called “members.” A member can be an individual, partnership, corporation, trust, or any other legal or commercial entity. A LLC can be managed by its members or by managers, but the management structure must be stated in the LLC’s certificate of formation. If more than one member owns the LLC, a member agreement is necessary to set forth the rights and obligations of the members.
Generally, the liability of the members is limited to their investment and they often enjoy the pass-through tax treatment afforded to shareholders of an “S” corporation.
Because of the tax classification rules and structural flexibility afforded to its members, those contemplating forming a LLC should consult with an attorney before choosing this type of business structure.
A General Partnership forms when two or more people associate to carry on a business for profit. The general partnership typically operates in accordance with a formal agreement between the parties known as a partnership agreement. There is no requirement that the agreement be in writing or filed with the State, but if the agreement is unwritten, the State implies many terms. Therefore, much care should be exercised to understand the implications of organizing in this manner.
When using this form of business entity, an assumed name certificate (commonly known as a “doing business as” or “d/b/a”) should be filed in all counties where business is conducted under the assumed business name.
It is important to understand that in a general partnership, all partners are personally liable for partnership debts and obligations.
A limited partnership is a partnership which contains one or more general partners and one or more limited partners. A limited partnership operates in accordance with a written or oral agreement between the partners, known as a partnership agreement. The partnership agreement dictates the general affairs of the limited partnership and how it conducts its business. The partnership agreement is not required to be publicly filed, but the limited partnership must file a certificate of formation with the Secretary of State. General partners are personally liable, but only for partnership debts. Limited partners can enjoy the same protections from partnership liabilities which corporate shareholders enjoy. For liability reasons, many limited partnerships have a corporation or an LLC as their general partner.
Limited Liability Partnership
A limited liability partnership is a limited partnership which has elected to limit its general partner(s)’ liability. Because of the limited liability afforded to the general partner, at least one managing partner of the limited liability partnership must bear liability for the entity’s actions in the same way owners of a general partnership are exposed. While limited liability partnerships share the same tax advantages of a limited liability corporation, their owners cannot be a corporation.
A non-profit organization is a business entity which uses its surplus revenues to achieve its stated goals rather than distributing them as profits or dividends. If a non-profit wishes to accept tax-deductible donations from donors, it must also apply for a designation as a charitable organization from the Internal Revenue Service.
Unincorporated Social Clubs
An unincorporated social club is an organization that is formed for “pleasure, recreation, and other similar purposes.” These organizations do not provide any goods or services to the general public. Common examples of social clubs include country clubs, college fraternities, homeowners’ associations, and hobby clubs.
Unincorporated social clubs are typically supported by membership fees, dues, and assessments and do not generate any profit. The organization’s net earnings cannot be for the benefit of any particular individual having a personal and private interest in its activities. Unincorporated social clubs may receive tax exempt status if they meet strict requirements specified by the IRS.
Choosing the right business structure can be a daunting decision. With the assistance of a skilled corporate attorney, you can make an informed and reasoned decision as to which type of business structure best suits your needs.
This article has been prepared for educational and informational purposes only and does not constitute legal advice. The laws of other states and nations may be entirely different from what is described in this article. Because of these differences, you should not act or rely on any information on this article without seeking the advice of a competent attorney licensed to practice law in your jurisdiction for your particular problem. The author has endeavored to comply with all legal and ethical requirements in writing this article and does not desire to solicit or represent clients based upon their review of any portions of this article which do not comply with the legal or ethical requirements of the jurisdiction in which the client is located. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship.