So What Business Structure Should You Choose?
Once you decide you want to start a business, the next question is where to begin. If you live in Texas, read our How to Start A Business in Texas Blog here for a starting point. Some of you might have chosen to make your company an LLC without actually knowing what that entails. Among the many questions you need to ask yourself in owning a business, the most important one might be what business structure you need to form or if your company is using the right legal structure?
Here is a general overview of the different types of Texas Business entities to guide you in making the decision. Each structure offers different advantages and disadvantages depending upon your potential risks, liabilities, investment needs, and tax situation.
Sole Proprietorship
As you might already know, this business structure is the most basic and a default structure, per se. In a sole proprietorship, a single individual is engaging in business activity without a formal organization. This individual is the sole owner and responsible for the asset and liabilities of the company. Some proprietors file a Doing Business As (“DBA”) to separate their legal names from their business names. The Texas Secretary of State charges $25 and the County Clerks charge about $15 for a DBA filing. This filing does nothing beside recognize that you are doing business in the allotted name. Besides the non-existence cost to form and maintain this business structure, there is no major advantage. The disadvantages, however, are many including no tax benefits, less credibility and no liability protection. Taxes are paid on pass through bases which means the business's net income passes through to the owner's individual tax return. The net income is then subject to income tax and self-employment tax. If you are doing business under this structure, consider forming a formal organization to protect you from liability and potentially enjoy some tax-benefits.
Partnership
There are three types of partnerships recognized in Texas: (1) General Partnership, (2) Limited Partnership, and (3) Limited Liability Partnership.
General partnership is the default structure for two or more people who come together and start a business. There is no filling requirement within Texas but similar to sole proprietorship, if the business operates under a name that does not include the surname of all of the partners, it is necessary to file a DBA with the county clerk. These individuals may have a partnership agreement, but it is not required to be filed with the Secretary of Texas. Although not formally required, having a partnership agreement in place will allow the partners to protect their interest. This structure has the same advantage and disadvantage of a sole proprietor. Each partner is liable for each respective partner’s liability. Further, each partner reports their share of profit and loss in the company on their personal tax returns.
Limited partnership has one or more general partners and one or more limited partners. This is simply to say there must at least be two members, one of which is a limited partner and the other general. This type of partnership typically takes place where there is a silent partner or an investor with no voting power who becomes a limited partner, and a general partner will be the one responsible for the management, daily operations, and the decision-making of the business. The general partners receive no liability while the limited partners enjoy unlimited liability. This is also another pass-through taxation structure where each partner reports his or her partnership’s profit and loss on their personal tax return. There is a filling requirement with a fee of $750 with the Texas Secretary of State. A partnership agreement is require by the state. In addition, an annual report must be filed to renew the registration along with annual fees. Due to the complexity of this arrangement, a partnership agreement is beneficial and set expectation from the onset.
Limited Liability Partnership is a type of general partnership where the partners' individual liability for the the partnership's obligations is limited. This type of structure is often formed by licensed professionals such as attorneys, accountants, or physicians with the intention of protecting each individual partner’s from liability for the other partner’s liability. However, any groups of two or more people can use this structure to form a parentship but they must have liability insurance of at least $100,000. There is a requirement to register this structure with the Secretary of State, the fee is $200 per partner. Further, an annual renewal filing and payment of the annual fee is required. This renewal falls due at the anniversary date of the first registration. By default, LLP is subject to pass-through taxation where the business's net income passes through to the owner's individual tax return. Thus, the LLP does not pay federal income tax. While it is not required to have a partnership agreement, it is highly recommended to have one for the partners’ protection.
Limited Liability Company (“LLC”)
An LLC is created by filing a Certificate of Formation with the Texas Secretary of State for $300. This filing separates the business from the owner. An LLC can be a one-member LLC or several people serving as members, directors, and/or managers. The beauty in this structure is that the filling automatically results in the protection of members from liabilities of the business. The personal assets of the members are thus separate and generally protected from a lawsuit unlike most of what we discussed above. An LLC also enjoys wide tax benefits in that it can (1) have the tax benefits and operational flexibility similar to a sole proprietorship or partnership, or (2) elect to be taxed as a corporation to enjoy the benefits that come with being taxed as a corporation. If the LLC is formed with no additional IRS tax election filling, this entity will be taxed as if it is a Sole Proprietorship. A member of an LLC can elect to be taxed as either C-corp or S-corp by filing an election form with the IRS. There is a requirement that must be met to qualify for these tax elections. Unlike corporations, there is no requirement for either an initial meeting of the owners or managers or an annual meeting. If the LLC is owned by more than one person, an operating agreement is beneficial among the members. An operating agreement outlines the ownership and member duties of your LLC, voting power, profit and loss allocation, management and the like. The benefit of this structure can phase out as your business makes more money or there rises a need to raise capital from the public.
Corporation
A corporation is typically how large businesses are set up and it is most beneficial to attract investment capital and sell stocks. Corporations enjoy limited liability, ease in the transferability of ownership interests, a perpetual duration and a centralized management known as board of directors. Forming a corporation may also be attractive to a small business owner who wishes to reduce tax liability, in some instances. A corporation is formed by filing a Certificate of Formation with the Texas Secretary of State for $300. This business entity has a more complex management structure in that it is governed by bylaws, which outlines the relationships of the various parties in the corporation such as shareholders, directors, or officers. Corporations, by default, are required to pay income tax on their earnings. This is an instant where double taxation may occur when taxed as a C-corp where both the company and the owners pay tax on the income of the corporation. To avoid double taxation, a corporation may elect to be taxed as an S-corporation if it meets the IRS criterial to file as an S-corp. A corporation formed under Texas law, must prepare corporate bylaws, appoint initial directors, hold first meeting of the board, and issue stock certificate to all shareholders. In a small corporation, it is also highly recommended that there be an optional shareholder agreement that shareholders may use to create certain rights and obligations among themselves.
There are also other business structures such as Professional Association, Non-Profit Organization and Foreign or Out-of-State Entities. The requirement, filings of these structures are specific to the needs of certain type of businesses. Any tax election such as C-corp or S-corp must be selected with a separate filing with the IRS.
Choosing the right type of business structure requires you to consider many different variables regarding how your business plans to operate. The Law Office of Ruthe Belachew, PLLC can answer your questions about business formation. The Law Office of Ruthe Belachew, PLLC strongly believes in minimizing potential legal liability and risk and will ensure your business is properly structured from the beginning.
Call today to learn more at (945) 900-2529.
