Business Entity Formation in Texas: Tax and Liability Considerations Part 2
Updated: Feb 17, 2022
Welcome back! In part 1 of this series, we took a look at the liability protection and federal tax treatment for some of the easiest to form and understand business entities in Texas. In part 2, we’ll take a look at those issues for the remaining two business forms. Although they’re more complex to form and operate, they also provide the most liability protection and tax flexibility.
First up is the corporation. The corporation is the most complex and formal of the business entities available in Texas. But, unlike sole proprietorship and partnerships, a corporation is a distinct and separate legal entity from its owners. This means strong liability protection for those owners, also known as shareholders. Their personal assets generally cannot be held liable for the corporation’s debts and obligations, or the wrongful actions of any other shareholders or employees. Another key difference is in taxation. For tax purposes, there are two major types of corporations: there are C corporations and there are S corporations, both named after the IRS code section in which they are found. The primary difference is that C corporations are separately taxed on the money they earn. Then, if the corporation distributes its profits to the shareholders that distribution is treated as income to the shareholders, and they have to pay taxes on it as well. This results in the dreaded “double taxation” of money earned through a C corporation. S corporations, by contrast, are not taxed at the corporate level; their earnings are reported and taxed only on the individual shareholder level. However, there are numerous restrictions regarding what kind of corporation can qualify for S status, many of which limit the utility of the S corporation for most businesses.
The Limited Liability Company (LLC) is probably the most popular business entity type in Texas. It is a hybrid between a corporation and a partnership. Like a corporation, an LLC is a distinct legal entity and therefore provides extensive liability protection to its owners. An LLC is also easier to form and, in Texas at least, requires fewer formalities in operations than a corporation. But it’s in the tax situation that LLCs are most distinct from corporations. LLC owners can essentially choose their tax status - they can opt to be taxed like a C corporation, or they can opt to be taxed like a partnership. Making the partnership tax election can provide two big benefits: first, company losses may lead to personal tax deductions and second, company profits aren't taxed twice as they are in C corporations.
I hope you found this brief overview of the types of business organizations available in Texas. If you have questions about which entity is right for you, I can help. Contact me today for a free consultation.