One of the first decisions you will face as a Texas business owner is choosing between a limited liability company (LLC) or a corporation.
Both of these entities can be great options for a business owner, but there are some important things to be aware of.
There are a lot of similarities between LLCs and corporations in Texas but also some important differences. The Curley Law Firm has created this guide to help you determine whether an LLC or corporation works best for your business.
The most crucial similarity between an LLC and a corporation in Texas is that both entities have limited liability for owners of the business. Because both corporations and LLCs are viewed as separate legal “persons” under Texas law, the entity itself is responsible for its debts and liabilities.
Generally, there is not a significant difference in the liability protection offered by an LLC vs a corporation in Texas. But it’s important to note that the limitation on liability might not apply in situations involving illegal activities or gross misconduct.
One of the most significant differences between a corporation and an LLC is in the formalities that the entity must follow.
Both entities must file formation documents with the Texas Secretary of State. Both entities must also file annual reports with the Texas Comptroller’s office and appoint a registered agent, but this is where the similarities tend to stop. In Texas, a corporation must create initial bylaws governing the operations of the corporation.
Corporations must also hold annual meetings (or pass a unanimous vote to not hold the meeting). LLCs do not require bylaws (typically referred to as an operating agreement for LLCs), nor are they required to hold annual meetings. Still, many LLCs choose to adopt these practices.
The owners of an LLC are called “members,” and there is generally only one class of ownership among the members of an LLC. For a corporation, this is not always the case. A corporation is owned by shareholders, and not all shareholders are created equally.
A corporation can issue different classes of shares, which may restrict things like dividend payments or the shareholder’s ability to vote in meetings. This adds to the complexity of a corporation but also gives it more options when it comes to ownership structuring.
If you are worried about protecting your privacy as a business owner, both LLCs and corporations provide some protection. Although Texas corporations and LLCs require public information reports, only the officers of a corporation are listed on the Comptroller’s website, not the shareholders.
For an LLC, the managers are listed in the report unless the LLC is “member-managed.” If you wish to keep the owners of your LLC confidential, you may want to elect for the LLC to be manager-managed.
Another key difference between a corporation and an LLC is the way the entities are taxed. Most corporations (sometimes called “C corporations,” as will be discussed below) are subject to a corporate income tax on their yearly profits.
The shareholders of a corporation typically do not pay taxes on the income of the corporation until they receive a payment (called a “dividend”) from it. Because corporations pay taxes at the corporate level and shareholders pay taxes on dividends, corporate income could be subject to double taxation.
LLCs, on the other hand, are pass-through entities. This means that the income of the LLC is passed directly to its members and taxed as personal income. An LLC can also elect to be taxed as a corporation.
A third option that lies between forming an LLC or a corporation is electing “S corporation” status. Either a corporation or an LLC may elect S corporation status, so long as the entity meets certain requirements. To qualify for S corporation status, the entity:
- Must not have more than 100 shareholders (or members);
- Must be owned by U.S. citizens or resident aliens;
- Must be owned by individuals or certain trusts, estates, or tax-exempt organizations; and
- May only have one class of stock.
Like an LLC, an entity that elects S corporation status is a pass-through entity. So the owners of the entity are taxed individually on its profits and losses.
Unlike an LLC, however, an entity with S corporation status can limit employment taxes for owners to the salary paid to the owner (so long as it is reasonable).
Pros and Cons of an LLC vs Corporation in Texas
Whether you choose an LLC or a corporation as your entity in Texas will depend a lot on the needs and complexity of your business. Both entities offer substantial benefits, but they each have their drawbacks as well.
Corporation Pros and Cons
Some of the key advantages of a corporation include:
- Limited liability,
- May appear more professional,
- More options for ownership structuring, and
- Advanced tax planning options.
Some of the disadvantages are:
- More complex formalities,
- Possibility of double taxation, and
- Additional costs due to formalities.
Corporations are important legal structures but not always the best option for a small business. Due to the additional complexity associated with a corporation, many business owners opt for an LLC instead.
LLC Pros and Cons
LLCs are a great option for small businesses and startups. Some of the advantages of an LLC include:
- Limited liability (like a corporation),
- Fewer formalities than a corporation, and
- Pass-through taxation.
The simplicity of an LLC does come at a cost. A few of the main drawbacks are:
- Possibility of self-employment tax,
- Fewer options for ownership structuring, and
- Costs of formation.
When comparing the advantages and disadvantages of an LLC vs a corporation, it is important to consider how complex you expect the ownership structure and tax situation to be for your business. A corporation is not necessarily a bad choice for a less complex operation, but an LLC could be a better choice.
Speak with an Experienced Business Attorney
Whether you are still unsure about the advantages and disadvantages of an LLC vs a corporation in Texas or you want to know more about making an S corporation election, Adam Curley is here to help.
Adam has been practicing business law for over ten years and has worked with a wide variety of businesses. Contact The Curley Law Firm today to discuss your options.