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CHOICE OF LEGAL ENTITY  This Article is designed to provide a basic summary about the differences between the following legal entities recognized by the State of Texas:  Corporations       Professional Corporations       Subchapter S Corporation Partnerships       Limited Partnerships       Registered Limited Liability Partnerships       Family Limited Partnerships Limited Liability Companies       Professional Limited Liability Companies Sole Proprietors Assumed Name Certificates or Doing Business As (d/b/a) Joint Ventures             There seems to be two major areas of concern when deciding the formation of a business: Taxes and Liability.  If a business is not operating in corporate form, professionals are taxed as individuals. That individual taxation may, however, be filtered through a form of a partnership, or limited liability company or an S corporation.  This does not mean the tax results are the same for all these entities. Each has its own quirks.  Likewise, each entity has different levels of liability associated with its owners. Due to the complicated nature of the tax code and the fact that taxation is not always based on the name of the entity, but many times based on the actual characteristics and functions of the entity, it is strongly recommended that you consult competent tax, financial and legal professionals.  This will help make sure you maximize your corporate structure to its full benefit. With this in mind here is a general overview of: Corporation. A corporation (Subchapter C or S) is created when two or more individuals, partnerships, or other entities join together to form a separate entity for the purpose of operating a business in the state. A corporation has its own legal identity, separate from its owners. The corporation offers protection to the business owners’ personal assets from debts and liabilities relating to the operation of the corporation. Taxation of the corporation varies depending on the type of corporation formed. A corporation must be registered with the Secretary of State. Subchapter C Corporation. A Subchapter C Corporation advantages include exemption of stockholders from personal liability; continuity of corporate existence in spite of death, incapacity of owners or managers, or changes of stockholders; transferability of ownership interest; limited liability of its stockholders; and standardized statutory methods of organization, management, and finance affording protection to stockholders and creditors. The chief disadvantages of incorporation are the expenses of incorporation, the necessity for complying with corporate formalities in the conduct of business affairs, the necessity for complying with state reporting requirements, and potential double taxation of corporate earnings.  From the tax standpoint, such disadvantage is more apparent than real, however, since the tax laws are not inflexible, and the harm that could result generally may be avoided by making proper choices and elections.  In actual practice, the decision to incorporate is often based on tax considerations. The major tax disadvantage of incorporation, potential double taxation of corporate earnings, exists only if earnings are distributed to stockholders as dividends.  Bona fide interest and rental payments made by the corporation to stockholders in return for the use of money or other property loaned by stockholders for use in the corporate business are ordinarily deductible by the corporation in computing its federal and state income taxes.  Even more important, the corporation will be entitled to deduct salaries paid to stockholders in their capacity as officers and employees of the corporation, and may also provide such fringe benefits as qualified profit sharing or pension plans, group term life insurance, stock bonus plans, and accident and health plans. Subchapter S Corporation.  In some circumstances, the S corporation may be a viable choice.  Like the LLC, it offers the limited liability of a corporation with most (but not all) the tax characteristics of a partnership. Income and deductions flow through to the individual shareholders and usually retain their tax character in the process. The Subchapter S Corporation also offers alternative methods for distributing the business income to the owners.    The S corporation avoids many problems of the "regular" corporation. An S corporation cannot be a personal holding company and cannot hold taxable accumulated earnings.  Double taxation of earnings is not possible and no question can be raised about the reasonableness of the salaries.   As with a partnership, the income of an S corporation flows through to the stockholders without being taxed at the corporate level. Most items of income and deductions retain their character when passed through, in the same manner as a partnership.   An S corporation nevertheless has drawbacks. For example, an S corporation cannot have more than 35 shareholders and shareholders are taxed on the earnings of the "S" corporation, even if those earnings are not yet distributed to the shareholder and are retained.  Nor can it have a corporate shareholder or a subsidiary, or engage in financial operations (insurance, banking).  The S corporation cannot issue a second class of stock unless the only distinction between the classes relates to voting rights.  There are fringe benefit problems such as any stockholder holding 2 percent or more of the stock is taxed on the value of the fringe benefits (a major exception exists for qualified retirement plans; those costs are deductible.). There are other disadvantages of an S corporation as well.  Though useful in some situations, professionals have tended to shun S corporations as an entity of choice.   Professional Corporations. A Professional Corporation is organized for the sole and specific purpose of providing professional services by shareholders who are licensed or otherwise duly authorized to perform those services.  The primary goal of professional organizations is to achieve for professionals a number of tax advantages available to corporate executives. Like a PLLC, the term "professional services," is defined in the act as any type of personal service that requires as a condition precedent to the rendering of the services such as a license, permit, certificate or other legal requirement. The definition applies to services that, by reason of law, cannot be performed by a corporation due to the professional’s license requirements.    Persons that may form professional corporations include: accountants, attorneys, chiropractors, dentists, insurance agents, licensed insurance adjusters, licensed professional counselors, nurses, occupational therapists, optometrists, physical therapists, podiatrists, psychologists, registered public surveyors, respiratory care therapists, and veterinarians.    Conversely, the following persons form business corporations rather than professional corporations: audiologists, engineers, pharmacists, private security investigators, real estate agents or brokers, security broker dealers, and speech pathologists.  These professions can incorporate under the Texas Business Corporation Act.  As noted under Professional Associations, physicians, surgeons and other doctors of medicine are specifically excluded from applicability of the Professional Corporation Act.    Foreign Corporations. Are entities formed in other states or countries. Texas State law requires that the foreign corporation obtain a certificate of authority to do business in Texas.  A certificate of authority will not be issued, however, unless the application for the certificate of authority states that the jurisdiction in which the foreign corporation is incorporated would permit reciprocal admission of the corporation if it were incorporated in Texas.   Professional Associations. Professional associations are regulated in Texas primarily by the Texas Professional Association Act. This act applies only to persons licensed to practice medicine by the Texas State Board of Medical Examiners, including medical doctors, osteopaths, and podiatrists.   The Texas Professional Corporation Act, specifically excludes physicians, surgeons and other doctors of medicine from the professional corporation’s act.  All other professionals should consider professional corporations, regular corporations, limited liability corporations, professional limited liability corporations and registered limited liability partnerships.   The Texas Professional Corporation Act and the Texas Professional Association Act do not affect existing law concerning the confidentiality of professional relationships or the professional liability of a practitioner to his or her client.    Partnerships. A general partnership exists when two or more individuals or businesses join to operate a business. Under a general partnership, a separate business entity exists, but creditors can still look to the partners' personal assets for satisfaction of debts. General partners share equally in assets and liabilities. A general partnership requires an annual partnership income tax return (separate from the partners' personal returns). A general partnership may be operated under the names of the owners, or a different name. In either case, an Assumed Name Certificate must be filed with the county clerk.   (continued) Back to top