Managing Attorney
Setting up a business in Texas is an exciting endeavor. Texas offers a vibrant economy, favorable tax environment, and a business-friendly atmosphere that attracts entrepreneurs from all walks of life. However, before diving headfirst into the world of business ownership, it’s essential to make informed decisions, starting with choosing the right business entity. From sole proprietorships to corporations, each structure comes with its own set of advantages and disadvantages.
In this guide, we’ll explore the various business entities available in Texas and provide insights to help you make the best choice for your entrepreneurial journey. Choosing the right business entity is a critical decision that significantly influences not only the day-to-day operations of your business but also your personal liability and tax responsibilities. Whether you are a solo entrepreneur or part of a group planning to establish a corporation, limited liability company, or limited partnership, understanding the distinct benefits and potential drawbacks of each entity type is crucial for the long-term success of your enterprise.
Our Houston corporate attorney guides you through the key factors to consider, such as legal protections, tax implications, and administrative requirements, helping you align your business goals with the most suitable legal structure.
What is a Business Entity?
A business entity refers to the legal structure under which a business operates. It determines how the business is taxed, the level of liability protection for its owners, and the administrative requirements it must fulfill. In Texas, entrepreneurs can choose from several business entities, each offering unique benefits suited to different business goals and circumstances.
How Do You Choose Your Business Entity?
There are many factors to consider when setting up a new business. Are you going to be the only person owning and running it? Will you have partners or other owners? Will it be online or brick-and-mortar? How much capital do you have to put towards startup costs? Do you need to raise capital from outside investors?
Whether or not you decide to incorporate is a critical decision that will have far-reaching consequences, so choose wisely. Let’s explore the types of entities available for Texas businesses.
Types of Business Entities in Texas
In Texas, entrepreneurs can choose from several business structures, each offering unique benefits and considerations. Here’s an overview of the different types of entities available:
- Sole Proprietorship: This is the simplest form and involves one individual operating a business. Formal organization is minimal, but if using a business name other than the individual’s surname, an assumed name certificate (DBA) must be filed with the local county clerk and/or the state. The drawback to a sole proprietorship is that the owner assumes unlimited personal liability for the company’s debts and obligations. This means that creditors can go after the owner’s personal assets (subject to state protection statutes) to satisfy business debts.
- General Partnership: Formed by two or more people who agree to operate a business for profit. In a general partnership, all partners have equal rights and responsibilities unless they elect to create a partnership agreement to govern their relationship. Like sole proprietorships, partnerships offer pass-through taxation, meaning that profits and losses are reported on the partners’ individual tax returns. However, partners are also personally liable for the partnership’s debts and obligations.
- Corporation: A more complex entity, created by filing a certificate of formation with the Texas Secretary of State. It offers limited liability, centralized management, and ease of ownership transfer. A corporation is a separate legal entity that is owned by shareholders. In Texas, there are two main types of corporations: C corporations and S corporations. A C corporation is subject to double taxation, meaning that the corporation pays taxes on its profits, and shareholders pay taxes on any dividends they receive. On the other hand, an S corporation is a pass-through entity, meaning that profits and losses are passed through to the shareholders and taxed at the individual level. While corporations offer the highest level of liability protection for their owners, they also come with more complex administrative requirements, such as holding regular meetings, maintaining corporate records, and filing separate tax returns.
- Limited Liability Company (LLC): An LLC is a popular choice for many small businesses in Texas due to its flexibility and liability protection. An LLC combines the pass-through taxation of a partnership or sole proprietorship with the limited liability protection of a corporation. This means that the owners (referred to as members) are not personally liable for the company’s debts and obligations beyond their investment in the business. Additionally, an LLC offers flexibility in management structure and fewer administrative requirements compared to a corporation.
- Limited Partnership (LP): Comprises at least one general partner and one limited partner, operating under a partnership agreement. Usually, the general partner is another entity and most commonly, either a LLC or a Corporation. This style of entity is generally preferred, because it can incorporate the benefits of partnerships and corporations as well as being the most tax efficient and flexible entity.
- Limited Liability Partnership (LLP): This type of partnership is available for general or limited partnerships wishing to limit the liability of their general partners. It requires registration with the Secretary of State.
- Limited Liability Limited Partnership (LLLP): This is a type of limited partnership that seeks to limit the liability for its general partners. It requires the state-formed limited partnership to file an LLP registration with the state.
Choosing the right entity involves considering factors like liability, tax obligations, management style, and the formality of operations, typically with the guidance of legal and financial advisors.
Legal and Tax Considerations When Selecting a Business Entity
A general partnership can be cemented with a handshake, but it’s best to have a written partnership agreement in place so everyone is clear on their responsibilities and rights. Partners pay taxes on their share of business earnings, but the business does not. In a general partnership, partners pay self-employment taxes on their earnings. No document needs to be filed with the state to create a general partnership and the general partners have unlimited liability for the debts and obligations of the general partnership.
The owners of an LLC are called members. Unless the LLC elects “S-Corporation status”, meaning rather than being a disregarded entity or a partnership, the LLC elects to be taxed as an S-Corp, there are no restrictions on ownership of an LLC and owners can include corporations, foreign entities, other LLCs, and individuals. As in a partnership, the members taxes on their allocated share of the company profits. The LLC itself does not pay taxes. If the business gets sued, the individuals are not liable. An attorney should file a certificate of formation and while an operating agreement (the governing contract between members) isn’t required, it is strongly recommended when an LLC has more than one member.
C Corporations
A Corporation electing to be taxed under Subchapter C is the most complicated type of entity. Owners of a corporation are called shareholders, but they pay taxes differently. A C corporation pays its own corporate tax at its own corporate tax rate. The shareholders of a C corporation pay tax on their dividends received. A corporation requires annual meetings of the shareholders, annual meetings of directors and other corporate formalities that make use of a corporation for some people, too complicated.
S-Corporations
An S-Corporation is a tax designation that elects pass-through taxation, rather than being taxed at the corporate level (in the event the entity that elected S-Corporation status is a state-formed corporation). State-formed corporations and LLC can both elect to be taxed as s-corporations, even though an LLC is not a corporation under the laws of the state. The reasons why an LLC would elect to be taxed as an S-Corporation are covered in another post. S-corporation shareholders/members must receive a “reasonable salary” before they are allowed to take profit distributions. Profit distributions from an s-corporation are not subject to self-employment tax. S-corporations have restrictions on its types of owners and those restrictions should be weighed carefully before opting to form an s-corporation taxed entity.
Limited Partnerships
A limited partnership is the most tax efficient and flexible business entity; however, there are complexities that come along with it. Limited partners do not pay self-employment tax on their distributable share of the limited partnership income. If paired with a subchapter c corporation, an individual can be a limited partner at the limited partnership level and a shareholder/employee of the general partner. A limited partnership is governed by the limited partnership agreement and so a limited partnership can give many, or less rights to the general partner. The limited partnership agreement can also elect to share profits with a non-equity partner via a profit allocation agreement, which is a contract between an individual and the limited partnership to share profits pursuant to a contract. Because limited partnerships are typically made up of a minimum of 2 entities, additional tax reporting obligations and costs should be considered before electing this type of entity.
Do I Need a Lawyer to Help Me Choose a Business Entity?
Consulting with a knowledgeable Houston business attorney is highly advisable when selecting a business entity. Legal experts can provide valuable insights into the most favorable tax structures and legal forms based on your specific business needs and growth objectives. They are also essential in adapting your business structure in response to both positive and negative changes in your business scenario.
Contact a Houston Business Law Attorney Today
Ensuring that your entity aligns perfectly with your business goals from the outset can save considerable time, money, and legal headaches in the future. Contact us today to leverage our expertise in forming the solid legal foundation your business deserves.
This is not intended to be legal advice. Please consult an attorney.