Entity Formation
Types of Entity Formations

The most commonly used business forms in Texas are the sole proprietorship, general partnership, C corporation, S corporation, limited partnership, and limited liability company. Other choices include the limited liability partnership, professional association, professional corporation, professional limited liability company, publicly traded partnership, and real estate investment trust.

Sole proprietorship. A sole proprietorship is not a legal entity. Instead, the business owner operates the business under his or her own name, or under an assumed name (or "DBA"). The owner is liable for all of the torts and contracts of the business, and must include all of its income on his or her personal tax return.

General partnership. A general partnership is a partnership between two or more individuals or entities. A partnership may be documented in a detailed written agreement, or may be created an oral agreement. If two people carry on a business as owners for joint profit, then they are partners. Although the partnership is a separate legal entity, the partners are jointly and severally liable for all of the contracts and obligations of the partnership. For federal income tax purposes, the partnership itself does not pay income taxes. Instead, each partner is required to report his or her share of the partnership’s items of income or loss. For Texas margin tax purposes, a general partnership is subject to taxation unless it qualifies as a "passive entity," or if all of its partners are natural persons.

Corporation. A corporation is a separate legal entity created by state law. Generally, the owners (called shareholders or stockholders) of the corporation are not liable for the debts and obligations of the corporation. A Texas corporation may be classified either as a C corporation or an S corporation for federal tax purposes. A C corporation pays federal and state income tax on its income. The owners are not taxed on the corporation's income, unless the corporation distributes a dividend. An S corporation provides some federal tax advantages over a C corporation. Generally, the income of an S corporation is not taxed at the corporate level and instead flows through to the shareholders similar to a partnership. However, the S corporation is not as flexible as a partnership. For example, all income and distributions must be allocated to the shareholders in proportion to stock ownership. Also, a distribution of appreciated property by an S corporation is treated as if the S corporation sold the property at fair market value. For Texas state law purposes, there is no difference between a C corporation and an S corporation. Both C and S corporations are subject to the Texas margin tax.

Limited partnership. A Texas limited partnership combines the flow through tax treatment of a general partnership, with some of the liability protection of a corporation. A limited partnership has limited partners and general partners. General partners of a limited partnership manage the partnership, and are jointly and severally liable for the torts and contracts of the partnership. Limited partners, as such, have no management rights and generally are not liable for the debts and obligations of the limited partnership unless they participate in the management of the partnership. However, limited partners may serve the partnership in other capacities (e.g., as an employee or an officer of the general partner) without losing their liability protection as limited partners. Because of the liability exposure of the general partner, often limited partnerships are formed with a corporation or limited liability company serving as the general partner. For Texas margin tax purposes, a limited partnership is subject to taxation unless it qualifies as a "passive entity."

Limited liability company. A Texas limited liability company, or LLC, combines the flow through tax treatment of a partnership, with the liability protection of a corporation. Unlike a limited partnership, no owner (called a "member") is required to be liable for the obligations of the company. The LLC is the most flexible of all entities. It can elect for federal income tax purposes to be a partnership or a corporation. If the LLC has only one member, then it may elect to be disregarded for federal income tax purposes. The LLC's organizational structure is also flexible. It may be managed directly by the members, or it may be managed by a separate board of managers who need not be members.

Professional Entities. Certain licensed professionals are prohibited by Texas state law from practicing their profession through a corporation. Texas has created special entities for these professions. Doctors and certain other health care professionals, for example, may practice through a professional association. Accountants and lawyers may practice through a professional corporation, professional limited liability company, or limited liability partnership. The professional will remain liable for his or her own professional malpractice. The entity can protect the professional, however, from contractual liability and from the malpractice of his or her partners.

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