When you’re starting a business in Texas, one of the most important decisions you will need to make is what legal structure to use. Your choice will affect how much you pay in taxes, the amount of recordkeeping you are required to do, and the degree of personal liability you face for business debts. Here’s a quick overview of the four most common business structures and the pros and cons of each.
Sole Proprietorship
In 2014, the Tax Foundation estimated that there were 23 million sole proprietorships in the country, making it the most popular business entity by far. The appeal is obvious: sole proprietorships are easy to create, you have complete managerial control, and all profits and losses are simply reported on your own personal income tax return.
The biggest drawback to running a sole proprietorship is that you, the owner, are personally responsible for all debts and liabilities incurred by the business. This puts your personal assets at risk unless you acquire insurance.
If you reside in Texas and plan to use a business name that’s different from your legal one (e.g. “Sue Anderson Consulting Services” instead of “Sue Anderson”), you are required to register your information with your local county clerk as an assumed name. There is a fee, but it’s minimal, and you must renew the assumed name every ten years.
Partnership
A partnership consists of two or more individuals who decide to go into business together and share its profits and losses. Like a sole proprietorship, profits and losses are reported by each partner on their personal income tax return, so there is no added tax burden for any profits realized. The main disadvantage is that each partner is personally liable for any financially obligations created by the business.
Partnerships come in two varieties: general and limited. With a general partnership, you and your partners manage the company and assume responsibility for its debts and liabilities. With a limited partnership, there are additional “limited” partners who are only investors. They have no control over the business and are not subject to the same liabilities as general partners. Limited liability partnerships may also be formed, where the general partners also have no personal liability for the debts and liabilities of the limited liability partnership.
Like sole proprietorships, general partnerships must be registered with your local county clerk if it is being run under an assumed business name instead of the individual names of the partners. Limited partnerships, including limited liability partnerships, must be filed with the Texas Secretary of State.
If you opt to form a partnership, creating a strong and mutually acceptable partnership agreement is crucial. It will answer important questions that can be prone to misinterpretation, such as each partner’s role in the day-to-day operations of the company, whether or not a partner can transfer their ownership to anyone else without approval, and what happens to the partnership interest upon the death of a partner.
Corporation
Corporations are structures specifically created to conduct business. Their primary benefit is that owners are protected from personal liability, so your personal assets cannot be seized to satisfy company debts. Corporations can also raise money by selling common or preferred stock. Unlike sole proprietorships, they can continue indefinitely, even if one of the shareholders sells their shares or passes away.
The main disadvantage is that corporations are more expensive to set up and run because more complex tax rules and regulations apply to them. Owners of C corporations also pay a double tax on the company’s earnings because shareholders must report and pay taxes on dividends. To avoid double taxation, you can form an S corporation, which passes income and losses through to shareholders to include on their individual tax returns, leaving only one level of federal tax to pay.
Limited Liability Company (LLC)
The LLC is a hybrid type of partnership that is becoming increasingly popular because owners are shielded from personal liability while remaining able to claim profits and losses on their personal tax returns. LLCs were originally established to provide business owners with liability protection while avoiding the double taxation dilemma. While this is an advantage also provided by an S corporation, LLCs have no limit on the number of shareholders they may have, while S-corps are limited to 75 shareholders. Also, unlike corporations, the LLC’s profits can be allocated to its owners differently from the percentage of ownership interest. This is particularly useful when one owner is more active in the business than the other owners, so that the active owner can receive more of the profit, while all the owners still have their proportionate voting rights.
Unlike corporations, LLCs cannot sell shares or stock, so raising public funds is problematic.
When deciding what business structure to take, it is important to consider the particular needs of the company and its owners. Fraser, Wilson & Bryan, P.C. can provide you with the advice and insights you need to make the right decision, guide you through the formation process, and represent you during any challenges so that you can focus on turning your unique idea into a successful business. Call us at (254) 965-7270 to schedule a consultation!
