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TAX ENTITY SELECTION

This a brief overview of the most popular forms of business organization. Each tax entity selection choice listed has certain tax advantages and disadvantages and may not be appropriate depending on the nature of your particular enterprise. If you are interested in starting a small business or have any tax questions about properly structuring your new business, please feel free to give me a call or email.  (214) 755-3108     Kelan@Kelan.net

SOLE PROPRIETORSHIP

This simplest form of business organization and also the easiest to create. The sole proprietorship is not considered a separate taxable entity from its owner and often operates in the owners name or under a "doing business as" (DBA) name. Income and expenses of the business are reported on schedule C of the individuals Form 1040 income tax return. The downside to sole proprietorships is that the business owner is personally liable for the ALL the obligations of the business.

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GENERAL PARTNERSHIP

A partnership is an association of two or more persons to carry on a business for profit. A partnership is generally formed with a written partnership agreement between the co-owners.

Although a partnership files a Form 1065 partnership tax return, it is not considered a separate taxpaying entity. The partnership return is a information return showing the items of partnership income and expenses that flow through to the partners individual Form 1040 income tax returns.

A potential downside to forming a general partnership is it that ALL partners have the legal authority to bind the partnership and other partners. You need to have complete trust in your other partners since they can basically make decisions in your name. Like a sole proprietorship, all partners are personally liable for the obligations of the partnership.

Note: General partnerships do not need to file or register their partnership agreements with the Texas Secretary of State.

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LIMITED PARTNERSHIP

A limited partnership consists of one (or more) general partners and one (or more) limited partners. A Texas limited partnership must file a Certificate of Limited Partnership with the Texas Secretary of State.

General partners have management authority with regard to the activities of the limited partnership. Limited partners on the other hand are simply cash investors in the limited partnership and do not have management authority.  General partners have personal liability for obligations of the limited partnership. Limited partners enjoy "limited liability" basically risking only the amount invested in the limited partnership.

Like a general partnership, a limited partnership is not a separate taxpaying entity. Items of income and expense flow through to the general and limited partners tax returns.

Often a limited partnership will be formed with a C corporation or S corporation as the general partnership. With a corporate general partner structure, the owners of the general partner corporation also enjoy the benefits of limited liability. The corporate partner files a Form 1120 or 1120S in addition to the Form 1065 for the limited partnership. The corporation must also pay Texas Franchise Tax to the Texas Comptroller.

Note: Limited partnership must file a Certificate of Limited Partnership with the Texas Secretary of State.

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LIMITED LIABILITY COMPANY

An LLC is also required to have an organizational agreement similar to a partnership agreement.

The LLC MAY be taxed as a partnership and therefore it is treated as a "pass through" tax entity with income and deductions reported by its members on their respective individual income tax returns.

All members of an LLC are shielded from personal liability for the obligations of the LLC. Likewise, managers are also shielded from personal liability. Unlike limited partners, LLC members can participate in the management of the LLC without losing their limited liability protection. Also, the LLC can have managers separate from the member owners.

There are no restrictions on who may be an LLC member and may have more than one type of membership interest.

Note: Limited Liability Company or LLC must file its Articles of Organization with the Texas Secretary of State and is subject to Texas Franchise Tax.

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CORPORATIONS

 A corporation is a legal entity having an existence separate from that of its owning shareholders.

Shareholders have no personal liability for the obligations of the Corporation, assuming the necessary corporate formalities are followed and a creditor is not successful in "piercing the corporate veil". In the state of Texas, a corporation may have as few as one shareholder and one director. The corporation must have a president, secretary, and treasurer who may be the same individual.

An Internal Revenue Code Subchapter C corporation is subject to federal income tax on its net income.

An Internal Revenue Code Subchapter S corporation is not generally subject to federal income taxation on the entity level. Items of income and deduction of an S corporation pass through to the shareholders and are reported on their individual Form 1040 income tax returns.

A regular C corporation may have more than one class of stock such as preferred stock or  non voting stock. This can be of supreme importance in family business succession planning. C corporations have no restriction on the number of shareholders. By contrast, an S corporation may only have one class of stock and is limited to a maximum of  75 shareholders. There are also other restrictions on the types shareholders that may invest in a S corporation.

Note: A corporation must first file its Articles of Incorporation with the Texas Secretary of State and is subject to Texas Franchise Tax.

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