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choice of entity

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.

Texas Statutes & Rules

Federal Statutes & Rules

Internal Revenue Code (IRC) - Title 26 of the United States Code
The IRC is relevant to the topic because it governs federal tax obligations, which are a primary consideration when choosing a business entity. Different entities are taxed differently under the IRC.

The Internal Revenue Code (IRC) is the federal statute that outlines how different business entities are taxed. Corporations are typically subject to corporate income tax, and shareholders are taxed on dividends (double taxation). Partnerships, sole proprietorships, and S corporations are generally pass-through entities, meaning the income is taxed on the owners' personal tax returns, avoiding double taxation. Limited Liability Companies (LLCs) can choose between being taxed as a corporation or a pass-through entity. The IRC also provides rules for deductions, credits, and other tax benefits that can influence the choice of entity.

Securities Act of 1933 - Title 15, Chapter 2A of the United States Code
This act is relevant because it regulates the offer and sale of securities, which is an important consideration for businesses seeking to attract investors.

The Securities Act of 1933 requires that any offer or sale of securities be registered with the Securities and Exchange Commission (SEC) unless an exemption applies. This registration process involves disclosing financial and other significant information to potential investors. The act aims to ensure that investors have enough information to make informed decisions. The choice of business entity can affect the complexity and cost of complying with these regulations, as corporations are typically subject to more stringent requirements than other entities like LLCs or partnerships.

Employee Retirement Income Security Act of 1974 (ERISA) - Title 29, Chapter 18 of the United States Code
ERISA is relevant to the topic because it sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for individuals in these plans.

ERISA does not require any business to establish a retirement plan, but it does require those that do to meet certain standards. The act is relevant to the choice of entity because it governs how employee benefit plans, including equity incentive plans like stock options, are managed, and it imposes fiduciary responsibilities on those who manage and control plan assets. Compliance with ERISA can be more complex for corporations than for other types of business entities.

Sarbanes-Oxley Act of 2002 - Public Law No. 107-204
This act is relevant for corporations, particularly publicly traded ones, as it imposes additional administrative and financial reporting requirements.

The Sarbanes-Oxley Act of 2002 was enacted in response to major corporate and accounting scandals. It established new or enhanced standards for all U.S. public company boards, management, and public accounting firms. It includes provisions such as the requirement to certify the accuracy of financial information and to establish internal controls and reporting methods on the adequacy of those controls. Private companies and other types of entities are generally not subject to these requirements, which can influence the choice of entity decision.

Limited Liability Company Act - Varies by State
While not a federal statute, the LLC Act is relevant as it governs the formation and operation of LLCs, which are a popular choice for businesses due to their flexibility in taxation and operation.

Each state has its own Limited Liability Company Act, which provides the legal framework for the establishment and governance of LLCs within that state. These acts typically allow LLCs to be treated as pass-through entities for tax purposes, unless they elect to be taxed as a corporation. They also provide for the limited liability of members, flexible management structures, and the ability to establish varying financial rights among members. The choice of an LLC as a business entity can be attractive due to these flexible provisions.