Texas is a relatively business-friendly state for incorporating a new business. The formation process itself can be deceptively simple.
There’s more than simply filing the certificate of formation – such as determining what type of entity you need, drafting a company or partnership operating agreement, tax planning, and post-formation tax compliance. Haphazard planning and lack of guidance cause issues for small business owners down the road.
- 1 Steps for incorporating a business
- 2 Advantages of incorporating your business
- 3 Types of business entities
- 4 Things to do after creating your LLC
Steps for incorporating a business
The actual process for creating an LLC or other business entity in Texas involves filing a certificate of formation through the Texas Secretary of State with the following information:
- Article 1 – Entity name and type
- Article 2 – Registered agent and registered office
- Article 3 – Governing authority
- Article 4 – Purpose
- Name of organizer
- Effective date of filing
Once the above has been submitted with a filing fee ($300 for an LLC), the Texas Secretary of State will respond with either a Certificate of Filing or rejection within 2 business days.
And that’s really it!
Clients can find many online companies and non-attorneys to create an LLC formation for a low fee. An attorney taking such a bare-minimum approach would be arguably committing legal malpractice.
Perhaps you want a business entity but aren’t serious yet about starting a company, or just want to impress your friends by creating an LLC. Any one of the low-cost online companies will suffice for that.
However, if you’ve put some thought into it and have a business plan, you probably don’t want to start your new company with the bare-minimum, especially for something as important as incorporation.
Advantages of incorporating your business
There are a number of benefits to incorporating a business. Most business choose to incorporate for three main reasons.
1. Limited liability protection
Shareholders of corporations, members of LLCs, and partners of LLPs, and limited partners of LPs enjoy limited liability protection from their entity’s liabilities, obligations, and debts.
2. Tax savings
Flow-through entities, such as LLPs and LLCs, can offer significant tax savings for a sole proprietor or a small business.
Having those letters after your business name lets potential customers know that you’re not a fly-by-night type of business.
Types of business entities
All Texas incorporated entities are essentially corporations, partnerships, or a hybrid structure.
An unincorporated business is a sole proprietorship if it has one member, and a general partnership if there is more than one member. Sole proprietors and general partners are personally liable for the company’s debts, obligations, and liabilities.
A corporation is a separate legal entity, but not to be confused with an LLC that is taxed as a corporation.
Shareholders have limited personal liability for corporate debts and obligations.
Because corporations are taxed as separate entities, there might be double taxation.
The corporation itself will pay taxes on it net earnings. Shareholders will also pay taxes on distributions from the company, whether in the form of dividends or officer compensation.
However, since the passage of the 2017 Tax Cuts and Jobs Act, double taxation is less of a concern after corporate tax rates were reduced to 21 percent from 35 percent. In addition, small businesses with less than 100 shareholders can elect for the corporation to taxed as a S corporation, thereby avoiding double taxation.
However, corporations require management formalities and can be both expensive and time-consuming to maintain.
For small business shareholders, a corporate structure is very rarely recommended. Larger companies that seek to attract outside investment may want to take advantage of a corporation’s flexible stock structuring and allocation of shareholder rights.
Limited Liability Partnerships (LLPs)
All partners of an LLP are limited liability partners and are not personally liable for the negligent acts of other partners or partnership employees, or for contractual obligations of the LLP.
LLPs are taxed like a general partnership – i.e., all profits and losses are allocated to each individual partner and reported on the partner’s individual income tax return.
LLPs might be recommended for professional services businesses where partners provide services independently of each other.
LLPs can be more expensive to maintain. The Texas Secretary of State imposes a $200 registration fee annually per partner.
Limited Partnerships (LPs)
A Limited Partnership (LP) consists of one or more general partners and one or more limited partners.
The liability of a limited partner is limited to the capital that he or she contributes to the partnership. However, the general partner has the same liabilities of as a partner would in a general partnership.
A general partner in a limited partnership can limit their liability in most situations by forming a Limited Liability Limited Partnership (LLLP).
Limited partnerships are not commonly used to structure a business, except where a general partner is seeking to raise investments. LPs are sometimes used in estate planning and commercial real estate investment.
Limited Liability Companies (LLC)
An LLC is a hybrid entity that is neither a partnership or a corporation, but contains characteristics of both. The owners of an LLC are known as members.
All members of an LLC have limited liability protection. By default, a single-member LLC is taxed as a disregarded entity and a multi-member is taxed as a partnership.
An election can be made to treat an LLC as a S corporation or a C corporation, making LLCs the most flexible option for the vast majority of small businesses.
A Texas professional business may also form a Professional Limited Liability Company. It’s similar to an LLC, except that all members of a PLLC must be licensed to provide professional services (e.g., lawyers, accountants, dentists, doctors, engineers, etc).
Things to do after creating your LLC
Make tax elections
Some business owners may want to change the way their default tax treatment. The IRS allows eligible entities to to change the way they are taxed.
Most commonly, a single-member LLC that is taxed as a disregarded entity may want to make an election to be taxed as an S-Corporation.
Apply for an EIN
You’ll need an EIN to file business returns as well as to open a business account.
Open a business account
One of the biggest reasons business owners decide to incorporate is limited liability protection.
Limited liability protection can, however, be disregarded in some situations. This is known as “piercing the corporate veil.”
Courts will look at whether the business owner commingled personal and business funds, such as, for example, paying private debts with business funds. And if so, the business could be considered a mere “alter ego” of the business owner.
Therefore, business owners should open a separate business account for their new entity and maintain a good accounting system.
Use your full entity name on documents
For limited liability purposes, a customer dealing with you must be aware that they are dealing with a business entity and not you personally. If a business owner fails to hold themselves out to the public as a separate business entity, a court will be more willing to pierce the corporate veil.
Therefore, good business practice involves using your full business name (or registered d/b/a) and the entity type after the name (or the use of an abbreviation – LLC, LLP, etc). This is especially important when drafting a sales or service contract.
Use a payroll service
Some business owners are required to pay themselves a reasonable salary from their company profits. If you have an LLC taxed as an S-Corporation, for example, all officers of the company must pay themselves a reasonable salary. You must file and pay payroll taxes every quarter, pay Texas unemployment insurance, and file Forms W2.
Make estimated tax payments
To avoid having to pay a massive tax bill at the end of the year, business owners should make any necessary estimated tax payments throughout the year.
Find a good accountant
This cannot be emphasized enough. One of the biggest drawbacks with hiring an online service to form an entity is that the company will file the paperwork and then off to the races you go.
We often have small business clients call us later down the road when they’re struggling with tax debt or dealing with an audit. If you’re serious about starting a new business, you should always hire a local attorney.
We maintain relationships with several accountants in the Houston area (trust me, good accountants willing to accept small business clients are very difficult to find). We provide a list of accountants to all clients and will help coordinate with them to ensure that they stay in tax compliance.