Choice of entity refers to choosing the legal form for operating your business. A business may be operated as (1) a corporation; (2) a general partnership or limited partnership; (3) a limited liability company (LLC); or (4) a sole proprietorship. Each state has its own laws for the formation, operation, and maintenance of these business entities.
The primary considerations in choosing the best form for operating your business are (1) protecting your personal assets from the liabilities of the company; (2) tax strategies designed to deduct early losses, avoid double taxation, and convert ordinary income into long term capital gain at a lower tax rate; (3) an entity that will be attractive to potential investors and lenders; (4) an entity that allows you to offer equity incentives to employees (stock options); and (5) the cost of forming the entity and properly maintaining it—including filing the required documents with state agencies.
In Texas, the choice of entity for operating a business is an important decision that affects legal liability, taxation, investment attractiveness, employee incentives, and administrative requirements. A corporation provides limited liability protection to its owners but may lead to double taxation, as income is taxed at the corporate level and again when distributed as dividends. However, electing S corporation status can avoid double taxation while still offering liability protection. General partnerships offer no liability protection, while limited partnerships protect limited partners but not general partners. A Limited Liability Company (LLC) combines the liability protection of a corporation with the tax benefits of a partnership, allowing for pass-through taxation. A sole proprietorship is the simplest form, with no separation between the business and the owner, leading to personal liability for business debts. Texas law requires different formation documents, such as certificates of formation and annual reports, and has varying tax implications for each entity type. The choice should consider asset protection, tax preferences, attractiveness to investors and lenders, the ability to issue equity to employees, and the costs of formation and maintenance. Consulting with an attorney and a tax advisor is recommended to determine the most suitable entity type for a specific business.
