Launching a new business requires a thoughtful process, usually in conjunction with an accountant and a lawyer, as there are financial, tax and legal implications that arise out of the choice of entity. Some business entities provide a method of shielding your personal assets from liability. Tax treatment varies depending upon the entity chosen. Some entities are better suited than others for bringing in outside investors. Management styles also vary.
The simplest form of business is the sole proprietorship. This is the form that many new entrepreneurs utilize, and particularly those providing consulting or other services. Many times the decision to operate as a sole proprietor is done due to a lack of funds to set up a formal business entity, or, may happen on a default basis when the new business owner fails to take steps to set up a formal entity. Generally, there are no formalities or filings required for a sole proprietorship, unless you want to operate under an assumed name or there are regulatory schemes in place for your type of business, e.g., health code permit requirements for restaurants and other businesses that handle food. From a liability standpoint, there is no limitation of liability between the business and the owners, so personal assets would be at risk for this type of entity. This may be a perfectly acceptable entity if you can cover risks through adequate insurance. From a federal tax standpoint, a sole proprietorship does not file a separate return. The owner simply includes the results of the business on his or her individual return on schedule C. The Texas Margin Tax does not apply to sole proprietorships. Sole proprietorships do not lend themselves to multiple owners.
A general partnership has many of the same attributes as a sole proprietorship, except that it has multiple owners. Although a writ- ten agreement between the owners is not necessary to form a partnership, parties are strongly advised to have a written agreement in place at the outset of the business arrangement to clarify relationships and agreements. like the sole proprietorship, personal assets are not shielded from liabilities of the partnership. Also, all partners are jointly and severally liable for all debts and obligations of the partner- ship. There is no federal income tax at the partnership level, as all gains and losses flow through to the partners. General partnerships owned by natural persons (not other legal entities) are not subject to the Texas Margin Tax.
A joint venture is a general partnership established for a specific purpose. in general, the same considerations set forth above for general partnerships are applicable to joint ventures.
A limited partnership is a more formal arrangement requiring filing of formation documents and payment of filings fees with the Texas secretary of state. One of the advantages of a limited partnership is that recourse against the limited partners is generally limited to the amount of the investment by the limited partner. At least one of the parties must be the general partner, responsible for managing the business. The general partner’s liability is not limited to her/his investment however, as she/he has full liability for the obligations and liabilities of the partnership. The general partner’s liabilities can be limited by forming a corporation or LLC to function as the general partner; however, this adds additional layers of complexity and expense to the business. Federal tax treatment is essentially the same as a general partnership in that there is no tax at the entity level and all gains and losses flow through to the partners. The Texas Margin Tax does apply to limited partnerships.
A corporation also requires the filing of organizational documents and a filing fee with the secretary of state. One of the advantages of a corporation is that generally the obligations of the corporation are those of the corporation only, and there is no recourse to the shareholders. A corporation is subject to corporate income tax at the Federal level, unless it files a subchapter s election with the IRS. Shareholders and employees are also taxed on distributions and income from the corporation, in effect subjecting the income to two levels of taxation. A subchapter s election with the IRS changes the tax treatment of the corporation such that no income taxes are paid at the corporate level, and income or losses flow through to the shareholders. The Texas Margin Tax applies to all corporations, whether or not a subchapter s election has been made. Corporations are good ownership vehicles if you bring in outside investors at the time of formation or if you anticipate you might do so in the future. They are also good if you desire to utilize a more formal management style.
Limited Liability Companies
A limited liability Company (LLC) also requires the filing of organizational documents and a filing fee with the secretary of state. Liabilities of the LLC are generally limited to the owner’s investment in the LLC without recourse to personal assets. An LLC can be taxed as either a corporation or a partnership, depending upon elections made at the time the entity is formed. LLCs are subject to the Texas Margin Tax. LLCs are also good vehicles for bringing in outside investors. Management styles for LLC can be quite simple or very complex, so provide a lot of flexibility.