Starting a business can be an exciting event, but choosing the right type of entity can be confusing.
There are a lot of options when it comes to Texas entities. Corporations, limited liability companies (LLCs), partnerships, and sole proprietorships make up some of your options. Each of these types of entities has its own advantages and disadvantages. Each type of entity also has different requirements when it comes to things like taxes, reporting requirements, and liability protection.
If this all sounds too complicated, don’t worry. Adam Curley has a wealth of business formation experience to share with you.
For smaller businesses and businesses just starting out, an LLC or sole proprietorship may be a good fit. The Curley Law Firm has created this guide to provide you with some basic information about LLCs vs sole proprietorships in Texas.
What Is an LLC?
A limited liability company or LLC is a legal entity formed under the laws of the State of Texas. You can create a Texas LLC by filing a certificate of formation with the Texas Secretary of State. In Texas, an LLC is owned by “members” who are often issued “membership certificates” designating their portion of the company. Members may be individuals or entities. An LLC is considered separate from its members for liability purposes but not necessarily for tax purposes.
Advantages of an LLC
Each entity has its own unique advantages and disadvantages. Some of the advantages of forming an LLC include the following.
Limited liability for the owners and officers of the LLC
Arguably the biggest advantage of an LLC vs a sole proprietorship in Texas is that members and officers of the LLC are not personally liable for the actions of the company. This can be a big advantage if you want to minimize the financial risks involved in running a business. That said, members and officers may still be liable in certain circumstances, such as deliberate wrongful acts.
Pass-through taxation
An LLC has a couple of options when it comes to income taxes. By default, an LLC is taxed as if it were a partnership or sole proprietorship. This means that income earned by the LLC “passes through” the entity and goes directly to the owners. An LLC may also elect to be taxed as a corporation, meaning that it will pay taxes at the entity level. Making this election could also mean the members pay additional taxes on distributions by the LLC.
Relatively simple formalities
An LLC is not as complicated to run as a corporation, but there are still some formalities that you must observe. You will need to file a certificate of formation to form your LLC. Your LLC will also need to have a registered agent located within Texas, but this does not have to be a member or a manager. Finally, your LLC will need to file annual reports with the Texas Comptroller.
Disadvantages of an LLC
LLCs are a great option for many businesses, but they do have a few disadvantages.
Initial formation costs
Forming an LLC does have some costs associated with it. In Texas, you will have to pay a fee to form your LLC. You may also have to pay an annual fee if you register your LLC to do business in another state.
More complex than a sole proprietorship
Although an LLC is less complex than a corporation, it is still more complex than a sole proprietorship. As mentioned above, you will be required to file a certificate of formation for your LLC. You will also need to designate a registered agent. You are not required to have an operating agreement or execute annual minutes, but it is highly recommended that you do so. An attorney can be a helpful resource to help you set up your LLC and comply with all state requirements.
What Is a Sole Proprietorship?
Although it’s a mouthful to say, a sole proprietorship is very simple. In essence, a sole proprietorship is just an individual running a business. Unlike an LLC, a sole proprietorship is not a separate entity. A sole proprietorship is just another way to say you are an individual with your own business.
Advantages of a Sole Proprietorship
The biggest advantage of a sole proprietorship in Texas vs an LLC is its simplicity and cost. Unlike an LLC or corporation, a sole proprietorship has no formal requirements to do business. Although there are not any mandatory steps to starting a sole proprietorship, there are still some steps you should consider taking to protect your business such as:
- Registering a trade name,
- Creating a bank account,
- Obtaining an employer identification number (EIN) (if necessary), and
- Buying an insurance policy.
As with any type of business, the steps needed will be particular to the specifics of your business. Your line of business, number of employees, and the size of your operations will all have an impact on what exactly your business’s legal needs will be.
Disadvantages of a Sole Proprietorship
The biggest disadvantage of a sole proprietorship is that there is no liability protection between you and your business. This means that you could be financially responsible for your business’s debts and liabilities. A sole proprietorship may also not appear as “professional” to others as an LLC or corporation.
Sole Proprietorship vs LLC in Texas: So Which One Is the Winner?
The simple answer is, it depends on what your needs are. An LLC is a great option for people who want a simple and cost-effective entity that will provide liability protection for their business. If, however, you are not yet ready for the costs associated with starting an LLC, a sole proprietorship may be a good option. Whether you want to start an LLC or a sole proprietorship, or you haven’t decided on an entity, the Curley Law Firm can help.