Your Guide to the Different Types of Business Entities

Your Guide to the Different Types of Business Entities by Hammerle Finley Law Firm

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If you’ve decided to start your own business, there are important first steps to take, including drawing up a precise business plan and securing the necessary capital to begin operations. Beyond that, it is extremely important to determine just what type of organizational structure you will use, and in Texas, you have many types of business entities from which to choose.

We’ll try to provide some preliminary guidance on business structure in Texas with this article, but it is intended for informational purposes only. Because your success may depend on choosing the entity form that is best for you, it is advisable that you seek the advice of an experienced business attorney to assist you in making the right choice and guiding you through the organizational process.

Filing Or Not Filing

In Texas, businesses can be broken down into two basic categories: non-filing entities and filing entities. Before creating your business structure, you must decide if you want to form a filing entity or not.

Non-filing entities are the most basic form of business structure available in the state. A non-filing business entity is formed without any formal action by the owner or the State of Texas. In other words, you just create your business, whatever it may be, and begin operations without filing any paperwork with the state government.

In contrast, filing entities can only be formed by filing a “certificate of formation” with the Secretary of State of Texas.

Non-filing Business Entities

In Texas, the two most common types of nonfiling business entities are the sole proprietorship and the general partnership.

  • Sole Proprietorship

This is the most basic type of business structure, a one-person operation conducting business for a profit. Under Texas law, the sole legal requirement is that if you’re conducting business under any name but your surname, you must file a “Doing Business As” (DBA) form with the county clerk’s office in the county where the business is located. The great drawback of the sole proprietorship is that you’re personally liable for debts and obligations of the business, and if you cannot pay your bills, creditors may go after your bank account and personal possessions to satisfy the debt.

  • General Partnership

This business structure is a slight step above the sole proprietorship and is essentially any association carried on by two or more people for a profit. Each person involved is a general partner, and they split profits and losses. One problem, however, is that if your partner loses a lot of money at their end of the business, they might sue you for half those losses. To avoid serious problems of this kind, it is highly advisable that you draw up precise rules specifying how your partnership will operate. Preferably, this should be done with the assistance of an experienced business attorney.

Filing Business Entities

Beyond the nonfiling business entities, things get more complicated, especially considering the array of options from which you have to choose.

  • Limited Partnership (LP)

The LP is the next step above a general partnership and offers a number of advantages over the latter. You form a limited partnership by filing a certificate of formation with the Texas Secretary of State.

There are two types of partners in an LP, general partners and limited partners. General partners act much like the partners in a non-filing general partnership. They conduct business operations and are also responsible for the partnership’s debts and obligations under Texas law.

General partners can be either natural persons or legal entities. Consequently, businesses often use a limited liability company (LLC) or a corporation as a general partner of the LP, providing personal liability protection to the owners.

Limited partners enjoy liability protection under Texas law, meaning they are legally protected from the debts and obligations of the partnership. However, they are not allowed to participate in the management or operation of the limited partnership. They are essentially “silent partners” investing money in the partnership but having no voice in how it is run. This arrangement is often used where an entrepreneur is looking for investors to provide the capital needed to start a business.

  • Limited Liability Partnership (LLP)

In this arrangement, all partners enjoy limited liabilities, and all are allowed to be involved in the management of the concern. Operating procedures can be spelled out in detail in the Limited Liability Partnership Agreement.

LLPs are often preferred by professional service businesses such as accounting, financial service, and law firms. The basic reason for this preference is that partners in the LLP are not responsible for the negligence or malpractice claims made against other partners.

  • Corporations

The corporation (also known as a C-Corp) is probably the best known business entity. Texas law views corporations as an entity separate from the owners, which means that when you organize a corporation you create a legal “person” that has the capacity to own property, sue and be sued, and also has to pay taxes.

Under most circumstances, a board of directors – chosen by the shareholders – governs the major operations of the corporation, including the appointment of executive officers who will conduct the day-to-day business affairs.

As to taxation, C-Corps are required to pay taxes on their profits before distributing dividends to its stockholders. Additionally, shareholders pay income taxes on the dividends received, and this double taxation is one of the major drawbacks of a corporation.

One way of reducing this tax burden is through the organization of an S-Corp, an entity subject to Sub-Chapter S of the Federal Tax Code. Ownership of an S-Corp is limited to U.S. citizens, resident aliens, and certain trusts and estates.  Business entities cannot own shares in an S-Corp. Ownership is also limited to 100 shareholders.  The great advantage of the S-Corp is its tax structure. An S-Corp has what is called “pass-through” tax status, meaning the S-Corp does not directly pay taxes on its income, which allows S-Corps to avoid the double taxation found in C-Corps. Rather the S-Corp’s shareholders report the flow-through of income and losses on their personal tax returns S-Corps, however, are responsible for taxes on certain built-in gains and passive income at the entity level.

One other corporate structure is the Benefit Corporation or B-Corp. Traditionally, corporations try to maximize profits for their shareholders. B-Corps are also organized for profit, with an additional corporate purpose of supporting some cause that in some way benefits the general public.

To say it another way: for entrepreneurs who want to create a business that not only makes money but has a social issue at its core, the B-Corp may be the entity of choice for you.

B-Corp laws became effective in Texas in September 2017. This corporate structure creates significant advantages for attracting and retaining employees who find the company’s purpose a primary reason for working there, as well as consumers who identify with and like to purchase from socially-conscious companies.

  • The Limited Liability Company (LLC)

The LLC is another form of business entity in Texas, created by filing a certificate of formation with the Texas Secretary of State. So, what is an LLC and how does it work?

An LLC is owned by one or more members and can be either member-managed or manager-managed. In other words, the owners can either manage the LLC themselves or elect mangers who will operate like a board of directors of a corporation. And like a corporation, executive officers can be chosen by the members or the mangers, depending on whether it is member-managed or manager-managed.

Unlike corporations, there is no requirement for either an initial meeting of the owners or managers or an annual meeting.

One of the great advantages of the LLC over a corporation is the pass-through tax benefit. LLC owners do not have to file a corporate tax return. Owners simply report their share of profits and losses on their tax returns, avoiding the double taxation paid by the traditional C-Corp’s shareholders.

  • Nonprofit Entities

A nonprofit organization is a business entity that has been granted tax-exempt status by the IRS because it furthers a social cause and provides a public benefit. Currently, the IRS lists 27 nonprofit types on its website, but when people think of nonprofits, they usually have in mind a 501(c)(3) organization. There are currently more than 1.5 million of these organizations in the U.S., and they are funded primarily through charitable donations and government grants. To obtain tax-exempt status a nonprofit entity needs to comply with the IRS regulations and the regulations of the Texas Comptroller.

In addition to the 501(c)(3) organizations, other common nonprofits include (501(c)(4) civic leagues and social welfare organizations, social advocacy groups, private charitable foundations, and corporate giving programs.

Beyond this summary of business entities available in Texas, you can find additional information on various aspects of business law in Texas.

Expert Business Law Assistance Is Available at Hammerle Finley Law Firm in Lewisville, TX

At Hammerle Finley, we turn ideas into reality by providing the very best support and advocacy in the area of business law. Whether you’re organizing a business for the first time or you’re an experienced entrepreneur in need of a knowledgeable ally, we’re here for you. Contact us today to schedule your initial consultation and let Hammerle Finley be your partner for success.