Congratulations, you’ve decided to start your own business. But now there are a thousand things to do before you can start welcoming customers into your office. One of the first things you have to consider is what you want the structure of your business to be – that is, how it will be seen for tax purposes and what protections it will provide you as owner. It’s a big decision, but thankfully there are only a few different options, and we’re about to discuss the pros and cons of each to make your decision easier.

Business structures in Texas

First, ask yourself why you started your business.  Obviously, you needed money to support your lifestyle, but there were certainly other reasons.  Maybe you wanted more freedom or flexibility.  Maybe you wanted a tax break or to create a generational business to hand down to your heirs.  Whatever the reason, the structure you choose for your business is critical to achieving your objectives.  In Texas, you have a few different options.

• Sole proprietorship – The simplest structure and easiest to start, the sole proprietorship does not require that any formation paperwork be filed with the Secretary of State.  You are simply a one-person operation that can act as you choose.  As easy as this structure is to launch, it does not provide as many benefits as other options.  The most notable downside is that you are personally liable for the business’s financial and legal problems.  Tax-wise, profits are taxed at your individual tax rate.
• General partnership – Like sole proprietorships, no state-required formation paperwork is needed to start a general partnership, although a formal partnership agreement detailing the terms of operation is advised to keep all partners on the same page.  This structure is ideal for two or more people seeking to launch a simple business with limited scope, perhaps to test the market for your products or services or to formalize a small business between friends.  However, all general partners are personally liable for the business’s debt and for the wrongful acts committed by other partners in the course of business.  That can be a scary proposition, but if your partners can be trusted and you all assume the risk, this structure can be a great launchpad for bigger things.  For tax purposes, profits flow through to partners to be taxed at their individual rate.
• Limited partnership (LP) – Filing a certificate of formation with the Secretary of State is required to form a limited partnership, as well as executing a partnership agreement that governs the business activities of the partners.  Under this structure, there must be at least one general partner and at least one limited partner.  As in the general partnership, the general partner is personally liable for the business’s liabilities, whereas the limited partner is not, unless they control the business or otherwise behave like a general partner.  In order to enjoy the protections this structure offers, the limited partner must also accept a smaller share of profits and less control.  Partners are taxed at their individual rates for passed-through profits.
• Limited liability partnership (LLP) – Under this structure, all of the partners are limited partners, so they all enjoy protection from personal liability of the business’s obligations.  An application for registration is required by the Secretary of State, and a partnership agreement is necessary to govern the partnership’s activities and the partners’ interests.  There are also annual reporting requirements necessary to maintain active status with the state.  Taxation is the same as with other partnerships.
• Limited liability company (LLC) – Whether it’s just you or other owners are involved in the business, an LLC affords all members of the company personal protection from the business’s liabilities, similar to shareholders of a corporation.  Filing of a certificate of formation is required to get started, and executing an operating agreement to govern the business is recommended, although not required.  LLC members are not subject to the double taxation suffered by certain corporations, as long as they elect to be taxed as a disregarded entity or S corporation (more on that later) so that profits flow through and are taxed at the member’s individual tax rate.
• Series limited liability company – This structure is popular with owners of multiple parcels of income-producing real estate, like apartment buildings or shopping centers.  In a series LLC, several different LLCs are formed under an umbrella, where each LLC owns separate assets (e.g., a boutique hotel) and is protected from the other LLCs’ liabilities.  Members also enjoy this protection for all LLCs in the series.  Similar paperwork is required by the state, and operating agreements are strongly suggested.  A variety of taxation options are available as well.
• Corporation – The only structure where shareholders own stock in the business, this option has been a mainstay for decades.  While stockholders are insulated from the liabilities of the corporation, unless you plan to take your company public or simply want the most formal business structure, another option may be better suited for your company.  That is because there are more formalities involved in starting and running a corporation, over and above the detailed certificate of formation and by-laws required in Texas.  However, shares in a corporation are easily transferable, and it can be simpler to raise capital without borrowing.  Another downside is the way corporations are taxed.  The default taxation method under the Internal Revenue Code is that corporate profits are taxable to the company and its shareholders must pay income tax on dividends as well.  This double taxation can be avoided by electing S corporation status, where profits pass through and are taxable only on a personal level to shareholders – but an S corporation cannot have certain entities own shares, like trusts and multi-member LLCs.

Making your choice

As you can see, there are pros and cons to each business structure, and the one you choose will depend on your goals for the business and your circumstances. Some other questions you should ask yourself before landing on a given structure are:

• How do you plan to raise capital?
• How many owners or partners will you have?
• How much control do you want your co-owners to have?
• How much potential personal liability can you tolerate?
• How much time will you have to keep up with filing requirements and tax obligations?
• Is transferability of ownership (shares or interests) a concern?

Having the right business structure can provide protection from corporate liability, minimize taxes, make it easy for investors to come on board if needed, and provide the foundation for years of success.

If you still have questions, you should consider speaking with an attorney and financial advisor. The professionals at TrustBridge Legal are standing by to answer your questions and help you make the right decision for your new business – and we’ll help you get started by filing all the required paperwork with the Secretary of State and drafting operating agreements or by-laws as necessary. Good luck!