When starting or buying a business, few decisions are as important as the choice of entity. There are several available: sole proprietorship, general partnership, registered limited liability partnership (“LLP”) , limited partnership (“LP”), limited liability company (“LLC”), and a general corporation (which can be structured for tax purposes as either an “S” corporation or a “C” corporation). In addition to these, a business can be can be structured as a Trust, or a conglomeration of one or more types of entities.
Several factors will influence the decision.
Most owners are interested in limiting their liability of entity “obligations,” meaning that the owners are not personally liable for the entity’s debts. All of the entities offer this type of protection except for sole proprietorship and general partnership.
Some of the entity choices require disclosure of the form within their name. A registered limited liability partnership must include those words, or LLP in the name. A limited partnership must include “Limited”, “LP” or “Ltd.” in its name. A limited liability company must include those words, or “Limited Company” or “LLC.” A corporation must include “Corporation”, “Company”, “Incorporated” or an abbreviation of those words.
The type of ownership varies. A sole proprietorship must be owned by an individual. An S Corporation has limited ownership. The remaining entities can have any type of owner.
A sole proprietorship has only 1 owner. A general partnership, LLP and LP must have at least 2 owners. A C Corporation can have unlimited owners, while an S corporation can have no more than 75 owners. An LLC can have 1 or more owners.
All investors will want to know if they can transfer their interests in an entity. An interest in a sole proprietorship is freely transferable. The owners of the other entities can transfer their economic interests, unless there is an agreement that expressly restricts the transfer.
Professionals can own interests in any of the types of entities.
Some entities have different classes of ownership, each of which has designated rights and duties. Only the sole proprietorship and the S Corporation are limited to one class of ownership.
The cost of properly filing an entity with the State is important. A sole proprietorship and general partnership are the simplest to establish, merely by filing an Assumed Name Certificate. The LLP requires an annual registration. The LP requires filing a Certificate of Limited Partnership, and the LLC and both corporations require filing Articles of Incorporation.
Taxation of an entity is a major factor in choice. In 1997, Federal entity tax moved to a “Check the Box” format, where classification is based on a 4-step process. For Federal tax purposes, a proprietorship and LLC (single individual member) is reported on a 1040, Schedule C or E. An LLC (single entity member) is taxes as a division of the member entity. A general partnership, LLC or LLP can qualify for taxation as a partnership ,a C or an S corporation.
For State tax purposes, the game changed in 2007. Prior to that, an LLC and a corporation were subject to Texas Franchise taxes, while the remaining entities were not. Effective January 1, 2007, almost every entity that does business in the State of Texas is subject to a new Margin Tax. Excepted are general partnerships with only natural persons, and sole proprietorships.