Small business owners know that one of the most important decisions they have to make when starting their businesses is under which business entity to operate. Many people in Texas know that a limited liability company can protect the business owner from being personally liable for the company’s debts, meaning that the business owner will not lose his or her personal property should the business amass debts it cannot pay. However, people may not be aware that LLCs can provide business owners with significant tax benefits.
Choice of Taxation Forms
Because LLCs are governed by state law, and therefore the rules for LLCs can vary from state to state, the federal government allows LLCs to elect which business entity taxation form to adopt for federal tax purposes. The flexibility means that business owners can enjoy all the protections an LLC offers while still getting the most favorable tax rate. An LLC can be taxed as:
- A “disregarded entity”: When only one person owns the LLC, the LLC has pass-through taxation, meaning the owner reports income on his or her personal taxes and pays self employment taxes and taxes on the profits. The LLC itself need not file any documents.
- A partnership: When more than one person owns the LLC, they may elect to have it taxed as a partnership, where the LLC must report its income on a partnership tax return but the members pay self-employment taxes on the business’ profits on their own tax returns.
- A C corporation: If the LLC is taxed as a C corporation, the entity itself pays taxes on profits. Additionally, if the business distributes dividends to the owners, they must pay a 15 percent tax on those dividends, the so-called “double taxation” people reference when discussing corporations. The owners do not pay self employment taxes, but the company is responsible for payroll taxes on salaries the owners draw.
- An S corporation: Owners of LLCs who elect to be taxed as an S corporation will still pay taxes on the company’s profits on their own income taxes but will not pay self employment taxes. The company pays payroll taxes on the salaries owners draw.
People looking to start LLCs in Texas must file certificates of formation with the Secretary of State. The owners of an LLC are called members. The members may choose to run the day-to-day operations of the business themselves, or they may elect managers to do so. The LLC’s certificate of formation must indicate which type of management structure the LLC has.
Talk to a Lawyer
Choosing a business entity can be a complicated decision, given all the factors a person must weigh. The best choice for a business depends on the owner’s goals, finances, product or service and personal circumstances. What works for one company may not be the best fit for another company. If you are thinking of starting a business, consult with an experienced business formation attorney who can discuss your situation with you and advise you of your options.