One of the most important decisions you will make when startinga new business will be the selection of a business structure(i.e. business entity). The main business structures available underTexas law are sole proprietorships, general partnerships, limitedpartnerships, registered limited liability partnerships, corporationsand limited liability companies.
Typically, the two main considerations when selecting a structureare the liability protections afforded an owner of the business, andthe federal and state tax implications associated with the structure.This article will provide a general overview of the foregoing businessstructures as well as the tax and liability implications associated witheach of them.
As a general rule, a business will always be liable forits debts and obligations regardless of the structure selected.Therefore, when making a selection, the issue ofliability is focused on who, if anyone, will be liable in theevent that the assets of the business are not sufficient tosatisfy the debts and obligations.
Business owners should also be mindful of all stateand federal tax requirements associated with the structure.At the federal level, a business may either be taxedat the entity level or may receive flow–through tax treatment.Flow–through tax treatment means that all gainsand losses are taxed at the owner level rather than theentity level. This tax treatment eliminates the doubletaxation of gains and losses associated with some businessstructures. At the state level, all types of entities doingbusiness in Texas will be subject to the Texas Margin Tax. However,some businesses such as sole proprietorships, general partnershipsowned solely by individuals, certain passive entities and businesseswith total revenues of $300,000 or less are exempt from the MarginTax.
A sole proprietorship is a business structure comprised of onlyone owner. A general partnership is a business structure comprisedof two or more persons or entities.
Sole proprietorships and general partnerships do not require anyformal filing with the Secretary of State’s office (unlike a LP, LLP, LLCor Corporation). Not surprisingly, they offer no liability protection totheir owners absent narrow homestead protection laws. This meansa creditor can look to a sole proprietor’s or partner’s personal assetsfor satisfaction of all business debts and obligations. An assumedname certificate filed with the county does not offer any liability protectionto the owners of a sole proprietorship or partnership.
Limited Partnerships and Registered Limited Liability Partnerships.
A limited partnership is a partnership formed by two or morepersons or entities, having one or more general partners and one ormore limited partners. Under a limited partnership, general partnersshare equally in the debts of the partnership. Limited partners havelimited debt obligations. A limited partner’s exposure is typicallylimited to the amount of their capital contribution; however, limitedpartners do not have a right to participate in the management of thebusiness. If they do, they may be exposed to unlimited liability forthe partnership’s debts and obligations. A limited partnership generallyprovides flow–though tax treatment to all partners of the LP.
In Texas, a registered limited liability partnership is a generalpartnership that provides its partners with limited liability protectionexcept for certain statutorily specified actions by the partners.To qualify, the LLP must maintain at least $100,000 of liability insurancecoverage or provide $100,000 of specifically designated andsegregated funds for the satisfaction of claims that would otherwisebe limited by the limited liability partnership status. A LLP typicallyprovides flow–through tax treatment to its partners.
Corporations.
A corporation is created when two or moreindividuals or entities join together to form a separateentity for the purpose of operating a business. A shareholder’s(owner’s) liability for the debts and obligations ofthe corporation are typically limited to the extent of theshareholder’s investment in the corporation.
The federal taxation of a corporation varies dependingon the type of corporation. There are two typesof corporations for federal tax purposes. In a C Corporation,the corporation is taxed at the entity level. Theafter–tax profits are taxed again when distributed to theshareholders.
In a Subchapter S Corporation, the corporation is generallynot taxed at the entity level but rather, at the shareholder level.To be treated as a Subchapter S Corporation, the corporation mustmake an election and meet certain requirements listed in the InternalRevenue Code.
Limited Liability Companies.
A limited liability company is an entity which has some aspectsof a Subchapter S Corporation and some aspects of a partnership.Similar to shareholders in a corporation, the members (owners) ofan LLC are usually not personally liable for the debts and obligationsof the LLC. Depending on the number of members of the LLC andthe election made by its members, an LLC may receive flow–throughtax treatment or may be treated as a corporation for federal tax purposes.
While taxation and liability protection are two of the main factorsto consider when choosing a business entity there are a numberof additional important factors which should be considered. Considerationmust also be given to capitalization requirements, formationexpense, interest transferability, management needs and ownerrestrictions.
It is beneficial to seek the advice of an attorney and financial professionalwhen determining which entity will best meet the objectivesof your business.
