Choice of Entity
§ 2.1Note on Personal Liability
The personal liability protections afforded by a limited liability company (LLC) or corporation apply in many contexts but not all. Creating a registered business entity will not protect against professional malpractice, intentional torts, or personal direct injury, but will likely help in case of other incidents that arise in the course of running a business. For example, an attorney who forms a professional limited liability company (PLLC) to practice law will not likely be personally liable for a slip and fall that occurs in the attorney's office but would still be liable for damages caused to clients by legal malpractice. These personal liability protections may also be lost if the corporate veil is pierced due to the owner failing to treat the business as separate from their personal affairs.
Control/Ownership: A sole proprietorship is owned by a single person. The entity is not formally incorporated or filed with the secretary of state and thus is the easiest type of business to start in terms of formal paperwork—one simply starts working as that business.
Liability: A major downside of a sole proprietorship is that the owner is completely liable for the entity’s debts. Unlike most other types of entities, sole proprietorships provide no corporate protection from lawsuits.
Tax Consequences: A sole proprietorship is considered a pass-through entity. Profits and losses “pass through” the entity to the owner, and its taxes are generally handled on schedule C of the owner’s individual tax return.
Formalities: Starting a sole proprietorship has no corporate formalities. To open a bank account in the name of the business, however, most banks will want to see an assumed name certificate (SOS Form 503, www.sos.state.tx.us/corp/forms/503_boc.pdf).
Administration/Flexibility: Due to the lack of formality, this is a very flexible choice of entity. For example, sole proprietorships are not required to follow corporate bylaws or resolutions.
Benefits/Drawbacks: The benefit of a sole proprietorship is ease of start-up and operation. The drawback is the lack of any sort of corporate protection from lawsuits and debts of the entity.
§ 2.3Limited Liability Companies (LLCs)
Control/Ownership: A limited liability company (LLC) is a formally filed entity owned by a member or members of the company. The members may elect to manage the day-to-day affairs of the company themselves in a member-managed LLC or to appoint a manager for that purpose in a manager-managed LLC.
Liability: LLCs provide a form of corporate protection for its members, in that the members are generally not liable for the debts or liabilities of the LLC.
Tax Consequences: Profits and losses from an LLC may be either pass-through or treated as those of a C-type corporation. If treated as a pass-through entity, an LLC will generally handle its taxes on schedule K-1 of the owners’ individual tax returns. If the LLC is treated as a corporation, it will have to file its own tax return and will pay taxes out of company revenue. Under corporation taxation, any dividends paid to members are taxed on members’ individual returns as well. While there are no state income taxes in Texas, the LLC may be subject to a state franchise tax if its revenues are over a certain threshold. In 2023, the threshold is $1,230,000.00.
Formalities: To form an LLC, a certificate of formation (SOS Form 205, www.sos.state.tx.us/corp/forms/205_boc.pdf) must be filed with the secretary of state. If the entity is required to file as a professional limited liability company (PLLC), a certificate of formation for a professional limited liability company must be used (SOS Form 206, www.sos.state.tx.us/corp/forms/206_boc.pdf). At a bare minimum, the certificate must list the entity name, the members and their addresses, the purpose, the registered agent and its address, and the name and address of the organizer. Other language may be added to convert the LLC into a different type of LLC (such as a series LLC). After the secretary of state approves the LLC, the company should create a company agreement spelling out the terms for operating and closing the company, as well as organizational minutes for its corporate book, which would grant the power to open a bank account, obtain a federal tax identification number, and anything else that may be needed for the company to begin operations. Most banks will require a copy of the certificate of formation, the company bylaws, organizational minutes, and the federal tax identification number before the bank will open an account in the LLC’s name.
Administration/Flexibility: LLCs may be very flexible, depending on the number of members and the company/operating agreement. Generally speaking, the fewer the members, the more flexible the LLC can be in terms of operation, notwithstanding that business records should be kept in an orderly fashion.
Benefits/Drawbacks: The LLC has become an overwhelming favorite entity choice in Texas due to the flexibility that it offers, the corporate protection it can provide, and the ease of operation, compared to a C corporation.
See part III in this manual for an in-depth discussion of LLCs.
Control/Ownership: Corporations are owned by their shareholders. Each shareholder holds an amount of “shares,” which are units of ownership. The shareholders elect a board of directors to oversee the general operations of the corporation. The board of directors then elects officers of the corporation to run the day-to-day operations. Currently, a Texas corporation is required to have only a president and a secretary. However, other officers may be elected, such as vice president, treasurer, and chief financial officer.
Liability: A corporation provides corporate protection for its owners in that the shareholders are not liable for the debts or liabilities of the corporation.
Tax Consequences: A corporation may be taxed as either an “S” corporation or a “C” corporation with the IRS. S corporation taxes are similar to pass-through taxes on an LLC, but S corporations have certain limitations that C corporations do not. C corporation taxes are traditional in the sense that the corporation files a return and pays taxes out of corporate revenue, and any dividends paid to shareholders will be taxed on the shareholders’ individual returns. As with an LLC, while there are no state income taxes in Texas, the corporation may be subject to a state franchise tax if its revenues are over $1.1 million.
Formalities: To form a corporation, a certificate of formation (SOS Form 201, www.sos.state.tx.us/corp/forms/201_boc.pdf) must be filed with the secretary of state. At a bare minimum, the certificate must list the entity name, the directors and their addresses, the purpose, the number of authorized shares, the registered agent and its address, and the name and address of the organizer. After the secretary of state approves the corporation, the corporation should create a set of corporate bylaws as well as organizational minutes for its corporate book, which would grant the power to open a bank account, obtain a federal tax identification number, and anything else that may be needed for the company to begin operations. Most banks will require a copy of the certificate of formation, the company bylaws, organizational minutes, and the federal tax identification number before the bank will open an account in the corporation’s name.
Administration/Flexibility: A corporation is arguably the most complex type of entity due to the required formalities, the taxation election, and the multiple levels of governance.
Benefits/Drawbacks: The benefits of a corporation are the corporate protection for shareholders and the ability to elect to be taxed as an S corporation if the corporation meets those requirements. A C corporation’s taxation is a drawback for most small businesses due to the double taxation requirement.
See part IV in this manual for an in-depth discussion of corporations.
§ 2.5Public Benefit Corporations (PBCs)
Control/Ownership: A public benefit corporation (PBC) is a for-profit corporation that must balance the shareholders’ monetary interests, the best interests of those persons materially affected by the PBC’s conduct, and the public benefit(s) specified in the certificate of formation.
Liability: A PBC provides corporate protection for its owners, in that the shareholders are not liable for the debts or liabilities of the PBC.
Tax Consequences: A PBC may be taxed as either an S corporation or a C corporation with the IRS. S corporation taxes are similar to pass-through taxes on an LLC, but S corporations have certain limitations that C corporations do not. C corporation taxes are traditional in the sense that the corporation files a return and pays taxes out of corporate revenue, and any dividends paid to shareholders will be taxed on the shareholders’ individual returns. As with an LLC, while there are no state income taxes, the PBC may be subject to a state franchise tax if its revenues are over $1.1 million.
Formalities: PBCs have the same formalities as C corporations. In addition, a PBC must have the words “Public Benefit Corporation” or “PBC” in its name and must state a specific social benefit on the certificate of formation. There is no SOS form for establishing a PBC, so organizers will have to create their own. Use SOS Form 201 for guidance.
Administration/Flexibility: Although a PBC is essentially a C corporation, it allows a company to consider more than just the shareholders’ monetary interests. The PBC can be a useful choice for a company pursuing a public benefit. A PBC must provide shareholders with a biannual notice about its public benefits, its progress, and its success in meeting those goals.
Benefits/Drawbacks: A PBC is a type of for-profit corporation new to Texas as of September 1, 2017. Although a PBC is for-profit, it is intended to produce a public benefit and to operate in a responsible and sustainable manner. However, these entities have additional requirements that C corporations do not.
See chapter 18 in this manual for an in-depth discussion of PBCs.
Control/Ownership: A general partnership is owned by at least two people. A general partnership is the easiest type of partnership to form, as it does not require any sort of formal filing with the secretary of state.
Liability: Similar to a sole proprietorship, all liability in a general partnership rests on the partners, and there is no corporate protection. Each partner is jointly and severally liable for the debts and liabilities of a general partnership; however, the law does require that, generally, a creditor of the partnership must exhaust its collection efforts using partnership assets before collecting partnership debts from an individual partner.
Tax Consequences: Profits and losses from a general partnership are considered pass-through to the partners, and its taxes are generally handled on schedule K-1 of the partners’ individual tax returns.
Formalities: There are no corporate formalities in terms of starting a general partnership. However, similar to a sole proprietorship, most banks will want to see an assumed name certificate (SOS Form 503) to open a bank account in the name of the business.
Administration/Flexibility: Similar to a sole proprietorship, a general partnership is a very flexible choice of entity due to its lack of formality, as it is not required to follow corporate bylaws or resolutions.
Benefits/Drawbacks: Similar to a sole proprietorship, the benefit of a general partnership is the ease of start-up and operation, and the drawback is the lack of any sort of corporate protection from lawsuits and debts of the entity.
§ 2.6:2Limited Partnerships (LPs)
Control/Ownership: A limited partnership (LP) is formed by one or more general partners and one or more limited partners.
Liability: The general partners have unlimited liability for the LP’s debts, similar to partners in a general partnership. Each limited partner, however, is liable only up to the amount of that limited partner’s investment in the LP. The operational difference between the two types of partners is the amount of management participation: general partners are set up to have all the management involvement, while limited partners are considered more like “silent investors,” with no input toward the operation of the LP. Any limited partners who participate in the management of the LP may lose their limited protection and become subject to the unlimited liability of general partners.
Tax Consequences: Profits and losses from an LP are considered pass-through to the partners, and its taxes are generally handled on schedule K-1 of the partners’ individual tax returns. An LP may be subject to a state franchise tax if its revenues are over $1.1 million.
Formalities: To form an LP, a certificate of formation (SOS Form 207, www.sos.state.tx.us/corp/forms/207_boc.pdf) must be filed with the secretary of state. At a bare minimum, the certificate must list the entity name, the general partners and their addresses, the registered agent and its address, and the address of the entity’s principal office. A partnership agreement spelling out the terms of the partnership should be drafted. Most banks will require a copy of the certificate of formation, the partnership agreement, and the federal tax identification number before the bank will open an account in the LP’s name.
Administration/Flexibility: Administration of an LP is dependent on the general partners. There is not a large amount of flexibility, due to the fact that any limited partners that participate in management decisions may be stripped of any liability protections they would otherwise have.
Benefits/Drawbacks: LPs are commonly seen in real estate development, as this entity type provides a source of funding without giving management authority to investors, unlike a corporation and its shareholders. However, that same lack of management authority may be considered a drawback to potential investors.
§ 2.6:3Limited Liability Partnerships (LLPs)
Control/Ownership: Limited Liability Partnerships (LLPs) are a form of a general partnership where each partner receives liability protection.
Liability: All of the partners in an LLP receive liability protection (compared with the partners of a general partnership) and are accountable only if the liability is due to the fault of a partner.
Tax Consequences: Profits and losses from an LLP are considered pass-through to the partners, and its taxes are generally handled on schedule K-1 of the partners’ individual tax returns. An LLP may be subject to a state franchise tax if its revenues are over $1.1 million.
Formalities: To form an LLP, a registration of LLP (SOS Form 701, www.sos.state.tx.us/corp/forms/701_boc.pdf) must be filed with the secretary of state. At a bare minimum, the registration must list the entity name, the number of partners, and the type of business the partnership is engaging in. A partnership agreement spelling out the terms of the partnership should be drafted. An annual statement must be filed each year for the LLP.
Administration/Flexibility: Administration of an LLP is dependent on the partnership agreement and the terms it sets out.
Benefits/Drawbacks: LLPs are commonly seen in professional settings, such as attorney firms. However, it can be quite cost-prohibitive, as the filing fees for an LLP are $200 for each limited partner, and each LLP must carry $100,000 in liability insurance.
See part II in this manual for an in-depth discussion of partnerships.
§ 2.7:1Professional Corporations (PCs)
A professional corporation (PC) is essentially the same as a C corporation, with the exception that only people in certain professions (attorneys, CPAs, architects—but not doctors) can establish this type of entity. Otherwise, PCs operate in the same fashion and are taxed and controlled as outlined in section 2.4 above. The certificate of formation for a PC is SOS Form 203 (www.sos.state.tx.us/corp/forms/203_boc.pdf).
§ 2.7:2Professional Limited Liability Companies (PLLCs)
A professional limited liability company (PLLC) is essentially the same as an LLC, with the exception that only people in certain professions (attorneys, CPAs, architects—but not doctors) can establish this type of entity. Otherwise, PLLCs operate in the same fashion as and are taxed and controlled as outlined in section 2.3 above. The certificate of formation for a PLLC is SOS Form 206 (www.sos.state.tx.us/corp/forms/206_boc.pdf).
§ 2.7:3Professional Associations (PAs)
A professional association (PA) is a hybrid of a PC and a PLLC created for physicians. It operates as a PC in terms of shares, bylaws, and so on, but owners are referred to as members instead of as shareholders. A PA may be used for only health professionals. The certificate of formation for a PA is SOS Form 204, www.sos.state.tx.us/corp/forms/204_boc.pdf.
Control/Ownership: A nonprofit corporation is owned by its members. The members may operate the entity themselves or select a board of directors. If the members opt for a board of directors, the board will in turn elect officers to run the day-to-day operations. Currently, a Texas nonprofit corporation is required to have only a president and a secretary. However, other officers may be elected, such as vice president, treasurer, and chief financial officer.
Liability: A nonprofit corporation provides corporate protection for its members, in that the members are not liable for the debts or liabilities of the nonprofit.
Tax Consequences: Once a nonprofit corporation is formed, it must apply to the IRS for federal nonprofit status to be exempt from federal taxes. If the nonprofit achieves exempt status, it should send the determination letter from the IRS to the Texas comptroller to gain exemption from further state franchise taxes and to receive a sales tax exemption.
Formalities: Arguably one of the more difficult entities to form, the nonprofit corporation requires several formalities including a certificate of formation (SOS Form 202, www.sos.state.tx.us/corp/forms/202_boc.pdf) and an application to the IRS for federal recognition. As with a C corporation, most banks will require a copy of the certificate of formation, the company bylaws, organizational minutes, and the federal tax identification number before the bank will open an account in the nonprofit’s name.
Administration/Flexibility: Nonprofit corporations are not well suited for flexibility, as nonprofits’ operations must fall within the framework of allowed nonprofit categories.
Benefits/Drawbacks: The benefit of a nonprofit corporation is exemption from corporate taxes, should federal recognition be achieved. Limitations on nonprofits, however, are severe, including restrictions on what activities they may engage in, restrictions on disposal of assets in the event of a termination, and prohibitions against members receiving any sort of dividends as payment.
See part V in this manual for an in-depth discussion of nonprofit corporations.
For additional content relevant to the topic of this chapter, see the following:
Assumed Name Certificate (SOS Form 503), www.sos.state.tx.us/corp/forms/503_boc.pdf
Certificate of Formation—For-Profit Corporation (SOS Form 201), www.sos.state.tx.us/corp/forms/201_boc.pdf
Certificate of Formation—Limited Liability Company (SOS Form 205), www.sos.state.tx.us/corp/forms/205_boc.pdf
Certificate of Formation—Limited Partnership (SOS Form 207), www.sos.state.tx.us/corp/forms/207_boc.pdf
Certificate of Formation—Nonprofit Corporation (SOS Form 202), www.sos.state.tx.us/corp/forms/202_boc.pdf
Certificate of Formation—Professional Association (SOS Form 204), www.sos.state.tx.us/corp/forms/204_boc.pdf
Certificate of Formation—Professional Corporation (SOS Form 203), www.sos.state.tx.us/corp/forms/203_boc.pdf
Certificate of Formation—Professional Limited Liability Company (SOS Form 206), www.sos.state.tx.us/corp/forms/206_boc.pdf
Registration of a Limited Liability Partnership (SOS Form 701), www.sos.state.tx.us/corp/forms/701_boc.pdf