- What can my choice of a business entity affect?
- What does "limited liability" mean?
- What are the available business entity forms in Texas?
- What is an "S-Corp," and how is that different from a regular corporation?
- Can an LLC make a subchapter "S" election? And if so, why would it want to do so?
- Do I need to form a professional entity?
- Is there a type of entity I should form, in general? I am just looking for an easy, simple answer.
What can my choice of a business entity affect?
Your choice of a business entity can affect your business in a number of ways, including, but not limited to:
- How your business is taxed;
- How the owners of your business are taxed;
- What type of business you can operate;
- The level of liability protection the law provides to the owner of the business;
- The rules governing the control and management of the business;
- Transferability of ownership;
- Business continuity; and
- The attractiveness of your business to third party investors.
What does "limited liability" mean?
Limited liability in the context of a business entity applies to the question of whether and to what extent the owners of a business entity can be made to answer for the debts of the business entity. In general, where a business entity provides limited liability to its owners, the owners are not personally responsible for the business entity's debts. But there are exceptions, most particularly in the case of owners of an entity who are also professionals rendering services for which malpractice liability may arise. The limited liability protection afforded by certain business entities also depends on the level to which the business entity maintains proper corporate form and complies with certain key laws.
What are the available business entity forms in Texas?
Texas law allows for the formation or registration of the following business entity types:
- Corporations;
- Professional corporations;
- Limited liability companies;
- Professional limited liability companies;
- Professional associations;
- Limited partnerships;
- Limited liability partnerships; and
- Nonprofit corporations.
In addition, businesses in Texas can be operated as sole proprietorships or as general partnerships without the need for a filing submitted to the Secretary of State. For an explanation from the Texas Secretary of State regarding the different types of available entities, please click here.
What is an "S-Corp," and how is that different from a regular corporation?
The designations of S-Corp and C-Corp refer to federal tax law and IRS regulations that govern how corporations are taxed. There is no distinction found under Texas state law. S-Corp's are not taxed at the corporate level, but shareholders of the S-Corp are taxed on their share of the entity's profits. C-Corp's are taxed at the corporate level, and if dividends are issued to shareholders, the shareholders are taxed individually on their dividends. Many small businesses electing to form as a corporation select the S-Corp classification to avoid double taxation at the federal level. But S-Corps have certain requirements that must be met with respect to the number and nature of their shareholders.
Can an LLC make a subchapter "S" election? And if so, why would it want to do so?
Yes. LLCs are, by default, taxed as partnerships. Partnerships are not taxed directly, but instead, the partners are taxed on their share of the partnership's profits. For LLCs, this means that the owners of the LLC are treated as partners in a partnership for federal tax purposes. This default tax classification allows LLCs to avoid double taxation. But LLCs can elect to be taxed as corporations instead. If an LLC elects to be taxed as a corporation and it meets the requirements for an S-Corp, then it can make a subchapter "S" election to avoid double taxation. Otherwise, the LLC will be taxed as a C-Corp, negating the double tax avoidance benefits.
A subchapter "S" election for an LLC may be preferable in certain circumstances over the default classification as a partnership due to the impact this classification will have on the owners of the LLC who actively manage and work for the business. This classification affects the level of self-employment tax the LLC owners must pay. For a detailed analysis of the implications as they relate to a particular business, you should consult the advice of a CPA who specializes in small business taxation issues.
Do I need to form a professional entity?
Texas law allows the formation of professional associations, professional corporations, and professional limited liability companies. If your business is formed for the purpose of providing professional services, you will need to form a professional entity. Some key restrictions regarding professional entities include:
- Professional associations may only be formed for the purpose of providing professional services rendered by a doctor of medicine, doctor of osteopathy, doctor of podiatry, dentist, chiropractor, optometrist, therapeutic optometrist, veterinarian, or a licensed mental health professional;
- Professional corporations may not be formed for the practice of medicine by physicians, surgeons, or other doctors of medicine, but may be formed for other professional services; and
- Professional limited liability companies may be formed for the purpose of providing certain professional services.
"Professional services" for the purposes of these professional entities means any type of service that requires, as a condition precedent to the rendering of the service, the obtaining of a license in Texas, including the personal service rendered by an architect, attorney, certified public accountant, dentist, physician, public accountant, or veterinarian.
Is there a type of entity I should form, in general? I am just looking for an easy, simple answer.
No. There is no generally correct or appropriate entity to form. The decision about which entity to choose depends on a number of factors related to your business and your business partners. Below is some key information about the various types of entities available, but if you are unsure about what is most appropriate for your business, you can retain the firm to provide you specific advice for your situation.
You may retain the firm online to advise you on the type of entity most suitable to your situation, or you may contact us to schedule a consultation (by retaining the firm online, you will receive a discounted rate for this service).
Some key issues to consider include:
- Corporations generally have more formalities and restrictions than limited liability companies, but it is often easier for shareholders to transfer ownership in a typically structured corporate entity.
- Corporations that do not meet the requirements to be S-Corps will be taxed at the corporate level, and shareholders will be taxed individually on dividends received.
- Limited liability companies provide the same level of liability protection as corporations, allow for greater flexibility in management, control, and maintaining the business structure, and can avoid double taxation by electing to be taxed as a partnership. They can also avoid double taxation if taxed as a corporation with the subchapter “S” election, provided that the ownership requirements are met.
- Active owners of a limited liability company or a partnership may be subject to self-employment taxes on all profits distributed from the business.
- Limited partnerships require a general partner who is personally liable for the entity’s debts. But the general partner can be another business entity, such as an LLC. Limited partners of a limited partnership receive liability protection.
