Starting your own business can be incredibly exciting. However, it isn’t all fun and games. There are many important decisions that must be made at the very beginning of an entity’s lifespan, such as how it will be capitalized, who will hold management authority, how the entity will be taxed and who will be liable for its contract, tort, and statutory obligations. One of the most important decisions business owners make is determining the type of entity for their business. While the distinction between entity types such as corporations, partnerships, and limited liability companies might not seem like a big deal, the reality is the type of business entity you choose can have a huge impact on the success or failure of your business. Business formation attorneys can help you make the right decision.
Corporations or “C-corps” are what typically comes to mind when you think of business entities. Corporations are an excellent option for entities with foreign ownership or many owners that desire to limit the liability of business operations for its shareholders. They also allow for the election of a board of directors to make business decisions (unless shareholder approval is required) and bind the corporation to business transactions.Also, on the plus side, C-corps allow for reinvestment of profits into the business at a lower corporate tax rate than other entities.Corporations do, however, have some drawbacks, including double taxation for many distributions, once at the business level and once at the owner level.
Partnerships are often used to form small businesses. There are three types of Partnerships: general partnerships, limited partnerships, and limited liability partnerships. General partnerships (GPs) are easy to create and operate. A GP is created any time two or more people agree to carry on a business for profit as owners. GPs are easy to form, but there are disadvantages. In a general partnership, all of the partners are personally liable for business liabilities, even if another partner incurs or causes them. Partners can help protect themselves by signing a partnership agreement, but many people never get around to drafting and signing these important business agreements.
Limited partnerships (LPs) are different from GPs. Instead of all the partners in the partnership being active members, LPs have limited partners that contribute funds to the LP, but do not participate in the decision making for the partnership and are not liable for the business liabilities. This entity allows for the flexibility of having a general partner, who is responsible for managing the entity and is liable for the debts of the LP, while the limited partners provide financial support for the entity. To obtain the liability protection for the limited partners, the entity must be created by filing a certificate of formation with the Secretary of State.
A limited liability partnership (LLP) can be formed by taking an existing GP or LP and registering it as an LLP with the Secretary of State. By doing this, all general and limited partners are given personal liability protection, meaning that owners will accept liability for their own intentional or negligent acts but not the torts of the other partners. LLPs are not as common because they are more expensive due to insurance requirements, the statutory filing requirements and yearly fees to maintain liability protection.
Limited Liability Companies
Limited liability companies, or LLCs, are extremely popular with business owners because they are easy to create and maintain. LLCs are a relatively recent addition to the world of business organizations in Texas. These entities have only been used since 1991 in Texas. In regard to obligations and liabilities, they resemble a corporation, but day to day operations tend to more closely resemble a partnership.LLCs can be managed by either the members or managers. Importantly, LLCs can provide both limited liability for all owners and partnership tax treatment for federal income tax purposes. Each owner is still liable for their own negligence, but not for the negligence of other owners. If the entity is used properly, the personal assets of the owners are not accessible to creditors of the company. In some situations, a single member LLC can be disregarded for federal income tax purposes, relieving the owner of the duty to file a separate tax return for the entity. The flexibility of an LLC and protection it offers to its members makes it a very desirable choice.
A C corporation can be adjusted and its federal taxation problem may be solved in some cases by the filing of a Subchapter S election with the Internal Revenue Service.This filing triggers partnership taxation for the corporation eliminating the double taxation problem. This form of entity is commonly referred to as an S-corp.S-corp owners report their share of profits or losses on their own personal taxes. However, S-corp status is available in limited circumstances: S-corps can only be created by legal U.S. citizens or permanent residents, there can only be one type of stock in the corporation, and it cannot have more than 100 shareholders. Maintaining S-corp status can be difficult, so this type of entity, while highly beneficial in some cases, must be used with caution to avoid the loss of its S-corp status with the IRS.
Sole Proprietorships are the most common form of business entity for a business owned by one person.Sole Proprietorships are easy to start and operate and do not require any formal state filings.On the negative side, and this is critical for most business owners, this form of business does not offer .any protection for the owner in the case of lawsuits or unpaid debts. The owner of a sole proprietorship is fully and personally liable for all debts and obligations of the sole proprietorship.
Business Formation Attorneys
The type of entity you choose for your business will have lasting effects.S o before starting your own business, schedule an appointment with one of our business formation attorneys in Austin, Beaumont, Houston, or San Antonio. We can help you build a strong foundation for success. Contact MehaffyWeber today.