Bustos Law Firm

Compare and Contrast Business Structures

In Business, Texas Law on October 18, 2011 at 10:35 AM

When forming a business, there are many different decisions to make. One of the first, and arguably the most important, is how to structure the business. There are many different options, but depending on how big the business will be, or what is important to the owner, there may be a clear choice.

Sole Proprietorship – A sole proprietorship is the smallest and simplest of the business structures. This structure only has one owner and is essentially an extension of that one owner; it is not a separate entity. The owner reports the business’s income and losses on his own personal income tax return. A sole proprietorship is the cheapest business structure because there are no filing fees with the Texas Secretary of State. There are, however, filing fees for an assumed name certificate (if the business is conducted under a name different from the owner’s) that must be filed in the county of principal business, or else in every county where business is conducted. Filing fees will vary from county to county, but on average range from $9-$20.

While this may seem like the best option for an owner who wants to start small and for as little money as possible, there are some drawbacks to the sole proprietorship. Because the business is not a separate entity, but merely an extension of the owner, there is absolutely no liability shield to the owner. The owner will be personally responsible for all debts and liabilities of the business. This includes any unforeseen tort claims that may be brought against the business.

Limited Partnership – A limited partnership (LP) is another structure that can be used by a smaller business. A partnership in general has to have at least two partners. In a LP, at least one of the partners has to be a general partner, and at least one of the partners has to be a limited partner. The LP must file a certificate of formation ($750) as well as an assumed name certificate ($25) with the Texas Secretary of State. It also must file an assumed name certificate in the county where the business is maintained, just like a sole proprietorship. The LP is governed by the partnership agreement which is created by the partners and does not need to be filed for public record.

The liability of the limited partner is, quite appropriately, limited. The limited partner will only be held liable up to the amount he contributed in capital. This is similar to the liability of a shareholder in a corporation. The general partner, however, has unlimited liability for the debts and actions of the partnership. Often limited liability companies or corporations will serve as a general partner in a LP because of the unlimited liability that attaches to the general partner.

A LP is taxed as though the gains and losses went directly to the partners. This means there will not be “double taxation” (taxed once at the entity level, and then again at the individual level), but instead the income and losses, and therefore taxes, will “flow through” to the partners.

Limited Liability Company – A limited liability company (LLC) is a hybrid of a partnership and a corporation. The LLC must file a certificate of formation ($300) and an assumed name certificate ($25) with the Texas Secretary of State, as well as an assumed name certificate in the county where the business is maintained. This business structure is known for being flexible by nature, and is attractive to many business owners for that reason. It can act more like a partnership or a corporation, depending on what is important to the owner.

LLCs can have multiple owners, including both individuals and other business entities. These owners are known as the members of the LLC and can choose how the business is managed. The LLC is a separate entity from the members. LLCs are taxed like partnerships, meaning there is no “double taxation”, but the gains and losses “flow through” to the members on an individual level. Additionally, LLCs do not have rigid formal requirements that are associated with corporations. For example, there is no requirement to record minutes in meetings.

LLC’s are similar to corporations in the liability of the members. Members in LLCs are treated like shareholders in a corporation, meaning they are usually only held liable for the debts or actions of the LLC up to the amount they contributed to the LLC. This is why LLCs are often used as general partners in LPs. Further, the members of a LLC are protected by the “corporate veil”. The veil is not bullet proof, however, and courts have found that the veil can be “pierced” when members abuse the privileges associated with a LLC and blur the separation of the LLC from the member.

Corporation – Corporations are the most formal business structure an owner can choose. In order to form a corporation, a certificate of formation ($300) and an assumed name certificate ($25) must be filed with the Texas Secretary of State. Additionally, the appropriate assumed named certificate must be filed in the county where the business is maintained.

The owners of a corporation are known as the shareholders. There are no limits on how many shareholders there can be in a corporation. There is also no limit to how many classes of stock a corporation can have. Shareholders have mainly a passive role, and only vote on issues that substantially affect the corporation, such as mergers. The managers of a corporation are known as directors and form the board of directors that runs the corporation. The board of directors elects officers to manage the day-to-day obligations of the corporation.

There are formal requirements that follow the formal structure of a corporation. For example, there is a requirement for minutes to be recorded in meetings, and there are strict standards on the bookkeeping procedures of a corporation. The benefit of having these formalities is that the shareholders will only ever be held liable to the extent of their contribution to the corporation. Shareholders will be protected by the “corporate veil” from being held liable for the actions and debts of the corporation.

The flipside, of course, is that the shareholders of a corporation will be subject to “double taxation.” The income and losses of the corporation will first be taxed at the entity level, and then will be taxed again when the shareholders receive a distribution and are taxed on that amount as income.

“S” Corporation – “S” corporations are those corporations that elect with the IRS to be treated differently for tax purposes. There are certain limitations on “S” corporations, meaning not every corporation can elect this beneficial tax treatment. For example, there can be no more than 100 shareholders, and the corporation can only have one class of stock. Additionally, the corporation must be a domestic corporation (be organized in the United States), and shareholders must be citizens of the United States. The benefit of electing this tax treatment is that the corporation is not taxed at the entity level, meaning the income of the corporation is only taxed once at the individual level and “double taxation” is avoided.

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