The following guest article on Starting a Business 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.
Starting a Business
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.
The Subchapter S corporation is a corporation that passes profits and losses through to its owners in the manner of a partnership. In Texas, the rules governing it are almost identical to those governing a Subchapter C corporation. A C corporation can become an S corporation by electing that status either at its incorporation or later, and by making that election with the Internal Revenue Service.
A corporation must use "Corporation," "Incorporated," "Company," or an abbreviation of one of those words in its name. It is formed by filing articles of incorporation with the Secretary of State of Texas, and by adopting bylaws for its operation. The Secretary of State charges a filing fee to record the articles of incorporation and issue a corporate charter. The corporation's term is typically perpetual unless the articles of incorporation limit its duration.
A corporation is a separate "person" under the law, and therefore, if it is properly organized and managed, it should protect its owners from any personal liability for corporate debts and obligations and from claims against the corporation. If a plaintiff "pierces the corporate veil," the shareholders are liable only to the extent of their individual ownership interests. There is no joint and several liability of shareholders.
Even though a corporation is a separate entity legally, it cannot represent itself in court. A corporate officer may represent the corporation only if he or she is a licensed attorney. The largest corporations tend to have in-house legal counsel, but most smaller enterprises use independent, outside counsel to update their corporate records, to offer legal advice on business plans and transactions, negotiate for them in business deals, and to represent them in court.
The owners of a corporation are its shareholders, who own shares of stock in the corporation. There may be no more than thirty-five shareholders of a Subchapter S corporation. Corporations, nonresident aliens, partnerships, certain kinds of trusts, pension plans, or charities may not be shareholders. There may be only one class of ownership interest, but different members of that class may have different voting rights. Shareholders may freely transfer their interests to others, but they may also sign agreements (usually called "buy-sell" or "stock restriction" agreements) to restrict the transferability of their shares.
All shareholders must make a contribution to purchase their stock. This contribution may be cash, promissory notes, real or personal property, services already performed, or securities. Shareholders are permitted to participate in the corporation's management. The withdrawal, death, or retirement of a shareholder does not trigger the dissolution of the corporation.
The shares of stock in a corporation are securities. The provisions of the Securities Act of 1933 apply, but if the corporation is not publicly traded, Section 4(2) of the Act or Regulation D may exempt them from its provisions. You should consult with an attorney experienced in securities law before planning to offer your corporation publicly.
Income is taxed at the corporate and at the shareholder level. Stock dividends receive fairly unfavorable tax treatment by the Internal Revenue Service, and so are often avoided in smaller corporations, especially where the owners work daily in the company's operations and so can receive bonuses in prosperous years. Special allocations of tax items are made pro rata according to the extent of stock ownership. Contributions on the formation of the corporation are taxable unless the transferors meet the 80% control test of Section 351 of the Internal Revenue Code. Shareholders may deduct subject to basis limitations, and the corporate debt is not included in calculating the basis. The IRS's "at risk" and "passive activity" limitations do apply if the corporation is a closely-held corporation. Distributions generally are not taxable to the extent of the shareholder's basis in his stock. The liquidation of a corporation is taxable at the shareholder level via a flow-through of the corporate items.
Most states have requirements to qualify a foreign corporation to do business in their state. If you plan to have your corporation do business outside of Texas, you need to know what those qualification provisions are and how to satisfy them.
If you decide to form a corporation, you should stay alert to these important points:
1. Make sure the corporation is properly formed. You must file articles of incorporation with the Secretary of State before the State of Texas can issue a charter for your corporation. After that, you must adopt bylaws, elect a board of directors, issue stock to the shareholders, and receive payment for that stock. It is also important to make sure that you capitalize your corporation adequately for its initial operations.
2. Maintain proper records. Your corporation should have its own bank accounts. Shareholders and directors should hold annual meetings, as well as special meetings whenever major matters of policy need to have guidance and decision. These meetings should be recorded in corporate minutes and kept in the corporate books.
3. Do not use the corporation as an extension of someone's personal will. In order to qualify for the corporate shield from personal liability, an owner needs to let the corporation live its own existence, separate from his life. The corporation should not pay personal expenses of the owner, or be standing in the owner's shoes for personal matters. If you fail to keep the line between your personal and corporate lives clean and distinct, you may wake up one day facing extensive personal liability for corporate actions.
4. Pay your taxes! The Internal Revenue Service imposes a 100% penalty on unpaid payroll taxes, and it can assess this tax against any "responsible person" in the corporation. Just what a "responsible person" is, is too broad to discuss here, but this is the IRS's term, and you can imagine how broadly they apply it! The State of Texas charges a franchise tax, too. Failure to pay the franchise tax can result in the forfeiture of your corporation's right to do business in Texas, and it will subject owners and others in control to personal liability for certain claims against the corporation.
To look at the other kinds of business entities that are available, click on one the following: