The following guest article on Types of Business Entities in Texas was written by James J. Burnett of Brownhill, Burnett & Associates, P.C. You can visit his web site at http:\\www.jamesburnett.com.
Types of Business Entities in Texas
NOTE: This article discusses business law matters of current note in the State of
Texas according to Texas law. The author is not licensed to practice law in states other than
Texas, and the following should not be taken as statements of what the law is outside that
state.
A limited liability company is a relative newcomer to Texas business law. It offers tax treatment
similar to that of a general partnership and limited partnership while providing protection from
personal liability for business debts and claims like that of a corporation. The limited liability
company does its business through managers, who may be the owning members or who may be
acting on their behalf, depending on how the entity is set up. One word of caution: Because the
limited liability company is a relatively new and a hybrid kind of entity, the Internal Revenue
Service may try to classify the entity as a corporation for tax purposes.
To form a limited partnership, the members file articles of organization with the Secretary
of State for Texas, and they adopt regulations. These documents are similar to the articles of
incorporation and bylaws found in a corporation. There is a filing fee to file the articles of
organization.
A limited liability company partnership must use the term, "Limited Liability Company,"
"Limited Company," "L.L.C.," "LLC," "L.C.," or "LC" in its name. Typically, it has a limited
term of existence in its articles of organization.
If properly formed and run, the limited liability company will shield its owners from
personal liability for the business' debts and claims against it. This is very important, because if
the business enterprise were to be classified as a partnership, the owners could have joint and
several liability for the debts and claims.
The owners of a limited liability company are its members. There is no limit on the
number of types of members a limited liability company may have, but it must have at least two
members to be considered a partnership for tax purposes. It can be owned by any number of
individuals or business entities. There may be different classes of ownership interests among the
members. Members may transfer their interests with full substitution for the transferee if the
articles of organization permit it, but there may be a tax issue if ownership interests are fully
transferable.
Members must make a contribution to purchase their interest in the limited liability
company. The contribution may be cash, property, services rendered, or a promissory note or
other obligation to pay cash or transfer property. The members may participate in the company's
management, but the participation of limited partners is restricted.
The withdrawal, death, or retirement of a general partner dissolves the limited liability
company unless the regulations provide otherwise, in which case there may be a tax issue arising
from the non-dissolution.
The members' ownership interests may be subject to the provisions of the Securities Act
of 1933. Whether they are "securities" under the Act probably depends on the level of member
participation. If you have any questions about how the Securities Act affects members' interests,
you should consult with an attorney experienced in securities law.
Income in a limited liability company is taxed at the partners' level if the company is
properly structured. Special allocations of tax items are permitted if the entity is a partnership for
tax purposes. Contributions on the formation of the company are not taxable unless there is a
disguised sale or the member is relieved from debts. Members may deduct their shares of
company losses subject to their basis limitations, but the company's debt is included in
calculating the basis. The IRS's "at risk" and "passive activity" limitations apply to a limited
liability company. Distributions are not taxable to the extent of a member's tax basis in the
company interest. The liquidation of a limited liability company is not taxable to a member to the
extent of his tax basis in the company's interest. Limited liability companies are subject to the
Texas franchise tax.
Most states have mechanisms for a foreign limited liability company to qualify to do
business there. If you plan to have your company do business outside the State of Texas, you
should speak with an attorney in that state who is experienced with its laws and regulations
concerning foreign limited liability companies.
If you decide to form a limited liability company, you should stay alert to these important
points:
1. Do your paperwork. You must file articles of organization and prepare regulations
to constitute your limited liability company. If you neglect these steps, you may find that you have
created a general partnership, exposing you and your colleagues to joint and several liability.
2. Stick to your game plan, especially concerning tax treatment of your business.
Your company's tax treatment, and your own as its owner, are vastly different depending on
whether your LLC is considered a corporation or a partnership for tax purposes. You should
consult with your accountant or tax consultant, and with your attorney, to determine the type of
tax treatment you want to have, and to learn how you need to structure and operate your LLC to
obtain that treatment.
3. Pay your taxes! The Internal Revenue Service can seek a one hundred percent
penalty for unpaid payroll taxes from a "responsible person" within the company. Just what a
"responsible person" is can be complicated, but as you can tell from the generality of the term,
it can turn into a dragnet that could well snare you, one of the company's owners. Also, the State
of Texas collects a franchise tax on LLC's, and failure to pay this tax can cause your company
to lose its right to do business in Texas and can expose its owners to liability for the company's
debts and claims against it.
To look at the other kinds of business entities that are available, click on one the
following: