It’s a great time for many closely held businesses to revisit their entity selection.
The Tax Cuts and Jobs Act (TCJA) has added a new twist to selecting the best type of entity for doing business in Texas. The federal corporate tax rate was lowered from a maximum 35% to a flat 21%; while at the same time a new 20% deduction was allowed for individuals with Qualified Business Income (QBI). It’s a great time for many closely held businesses to revisit their entity selections.
Selecting the best entity for your business has important tax and legal ramifications. Below are some points to discuss with your CPA and attorney. Call us at (940) 539-3238 to learn more.
In general
Sole proprietorships are best suited for single owner entities that do not need liability protection, are not concerned with mitigating self-employment taxes and do not need to raise or accumulate capital. Sole proprietorships have relatively few administrative requirements and are simple and inexpensive to form. Personal assets may be seized to satisfy business obligations or debts.
Partnerships are best suited for multiple owner entities that do not need liability protection, are not concerned with mitigating self-employment taxes and do not need to raise or accumulate capital. Partnerships have relatively few administrative requirements and are simple and inexpensive to form. Partners may not be employees of the partnership. Personal assets may be seized to satisfy business obligations or debts, and partners are joint and severally liable.
Limited partnerships are best suited for multiple owner entities that do not need liability protection for general partners, are not concerned with mitigating self-employment taxes and do not need to raise or accumulate capital. Partners may not be employees of the partnership. Limited partnerships have relatively few administrative requirements. Assets of general partners may be seized to satisfy business obligations or debts, and general partners are joint and severally liable. Limited partners can not be active participants in the day-to-day operations of the business. An LLC may be created to serve as the general partner. Owners may not claim tax losses in excess of their investments.
The LLC is best suited for entities that need liability protection, are not concerned with mitigating self-employment taxes and do not need to raise or accumulate capital. The LLC has relatively few administrative requirements. Income is passed through to the members, unless the LLC elects to be taxed as a c-corporation. All members may participate in the day-to-day operations of the business and, typically, assets of members may not be seized to satisfy business obligations or debts. Ownership interests are typically not freely transferable and, in Texas, are not considered attachable property. Owners may claim tax losses in excess of their investments, such as on certain leveraged real estate investments.
The S corporation is best suited for entities that need liability protection, are concerned with mitigating self-employment taxes and do not need to raise or accumulate capital. Entities taxed as an s corp may be able to reduce self-employment taxes by paying owner-employees both salaries and distributions. Ownership interests are freely transferable and, in Texas, are considered attachable property.
C corporations are best suited for entities that desire to go public, raise capital or accumulate capital for expansion or to service debt. Ownership interests are freely transferable and, in Texas, are considered attachable property.
The information provided above is not meant to be legal or tax advise. You should consult your CPA and attorney to determine the best structure for your entity.
See also: New Tax Law. What’s Hot. What’s Not.
~Mitzi E. Sullivan, CPA
M.E. Sullivan is a cloud based professional services provider specializing in cloud accounting.
Additional information is provided by the Texas Secretary of State and copied below:
- Sole proprietorship: The most common and the simplest form of business is the sole proprietorship. In a sole proprietorship, a single individual engages in a business activity without necessity of formal organization. If the business is conducted under an assumed name (a name other than the surname of the individual), then an assumed name certificate (commonly referred to as a DBA) should be filed with the office of the county clerk in the county where a business premise is maintained. If no business premise is maintained, then an assumed name certificate should be filed in all counties where business is conducted under the assumed name.
- General partnership: A general partnership is created when two or more persons associate to carry on a business for profit. A partnership generally operates in accordance with a partnership agreement, but there is no requirement that the agreement be in writing and no state-filing requirement. If the business of the partnership is conducted under an assumed name (a name that does not include the surname of all of the partners), then an assumed name certificate (commonly referred to as a DBA) should be filed with the office of the county clerk in the county where a business premise is maintained. If no business premise is maintained, then an assumed name certificate should be filed in all counties where business is conducted under the assumed name.
- Corporation: A Texas corporation is created by filing a certificate of formation with the Texas Secretary of State. The Secretary of State provides a form that meets minimum state law requirements. Online filing of a certificate of formation is provided through SOSDirect.A corporation is a legal person with the characteristics of limited liability, centralization of management, perpetual duration, and ease of transferability of ownership interests. The owners of a corporation are called “shareholders.” The persons who manage the business and affairs of a corporation are called “directors.” However, state corporate law does provide for shareholders to enter into shareholders’ agreements to eliminate the directors and provide for shareholder management. Choosing the best management structure for your corporation is a decision you make with the advice of an attorney. The Secretary of State cannot assist you.
An “S” corporation is not a matter of state corporate law but rather a federal tax election. A for-profit corporation elects to be taxed as an “S” corporation by filing an election with the Internal Revenue Service. Please contact the IRS or competent tax counsel regarding the decision to be taxed as an “S” corporation and the requirements for filing the election. This is not a matter with which the Secretary of State may assist.
- Limited Liability Company: A Texas limited liability company is created by filing a certificate of formation with the Texas Secretary of State. The Secretary of State provides a form that meets minimum state law requirements. Online filing of a certificate of formation is provided through SOSDirect.The limited liability company (LLC) is not a partnership or a corporation but rather is a distinct type of entity that has the powers of both a corporation and a partnership. Depending on how the LLC is structured, it may be likened to a general partnership with limited liability, or to a limited partnership where all the owners are free to participate in management and all have limited liability, or to an “S” corporation without the ownership and tax restrictions imposed by the Internal Revenue Code. Unlike the partnership, where the key element is the individual, the essence of the limited liability company is the entity, requiring for its creation more formal requirements. 1 William D. Bagley & Phillip P. Whynott, The Limited Liability Company, §2.10, (2d ed. 2d rev. James Publishing, 1995).
The owners of an LLC are called “members.” A member can be an individual, partnership, corporation, trust, and any other legal or commercial entity. Generally, the liability of the members is limited to their investment and they may enjoy the pass-through tax treatment afforded to partners in a partnership. As a result of federal tax classification rules, an LLC can achieve both structural flexibility and favorable tax treatment. Nevertheless, persons contemplating forming an LLC are well advised to consult competent legal counsel.
A limited liability company can be managed by managers or by its members. The management structure must be stated in the certificate of formation. Management structure is a determination that is made by the LLC and its members. The Secretary of State cannot give advice about management structure.
- Limited Partnership: A Texas limited partnership is a partnership formed by two or more persons and having one or more general partners and one or more limited partners. The limited partnership operates in accordance with a partnership agreement, written or oral, of the partners as to the affairs of the limited partnership and the conduct of its business. While the partnership agreement is not filed for public record, the limited partnership must file a certificate of formation with the Texas Secretary of State. The Secretary of State provides a form that meets minimum state law requirements. Online filing of the certificate of formation is provided through SOSDirect.
- Limited Liability Partnership: In order to limit the liability of its general partners, a general or limited partnership may opt to register as a limited liability partnership. The Secretary of State provides a form for registration as a limited liability partnership. Online filing of the registration is provided through SOSDirect.
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It’s official. The new tax law has been signed. And it just keeps coming!
Deductions for business interest expenses are capped at 30% of AGI. Meh. Only affects the really big boys.
Mitzi's Musings 