Too Small To Form A Texas Corporation Or Llc
Not long ago, I received an interesting email query from a University of Texas MBA student
. The MBA student wanted to know if he should incorporate a part-time consulting business he had started, given its small scale.While his question is one that people from any state can ask, the nuances of Texas corporation and limited liability company formation and taxation slightly complicate the answer for Texas small businesses. As a result, potential entrepreneurs need to carefully consider three factors:
Factor #1 - Legal and Formation Costs of Incorporation
A first thing to think about when contemplating incorporating in Texas is the initial cost of incorporation.
The good news here is that incorporation represents a pretty good bargain.
The fee to file the articles of incorporation (also known in Texas as a "certificate of formation for a for-profit corporation) or the articles of limited liability company formation run $300. Note that you can pay the fee by check, money orders, or credit card, but if you pay by credit card, the state dings you an extra 2.7% credit card convenience fee.
While $300 isn't that much, the fee is high enough to mean that many very small businesses probably shouldn't incorporate. A home party business, a tiny hobby business--and maybe even a part-time consulting gig--may not generate enough revenue to justify paying the setup fee.
Note: You absolutely can file your articles of incorporation yourself, but if you need help from a lawyer or CPA your costs rise.
Factor #2 - Tax Return Preparation Costs
Another factor to consider when you're talking about setting up a corporation or limited liability company for a small Texas business is the on-going accounting costs of running the venture as a corporation or LLC.
And here, unfortunately, one encounters some bad news--at least for the incorporation option. If you run your business as a corporation (including as an S corporation), your business owes a corporate tax return. And that corporate tax return will require you to pay several hundred dollars to some small business accountant for tax return preparation.
Note: You can buy do-it-yourself tax preparation software that lets you prepare a corporation return. But a corporation is much more involved than an individual tax return. Accordingly, while many accountants will recommend people file their own individual tax returns using, for example, do-it-yourself tax software, few accountants will recommend people file their own business tax returns using such software.
By the way, the really interesting thing about a small limited liability company is that if the LLC is owned by a single person or if the LLC is owned by husband and wife, the LLC's income and deductions can be reported on the owner's (or the husband-and-wife owners') tax return. That means the LLC doesn't need its own (expensive) tax return.
For many micro-businesses, obviously, the limited liability company option is attractive.
Note: In a community property state like Texas, an LLC owned by a husband and wife may also show the entity's income and deductions on their joint 1040 tax return.
Factor #3 - State Franchise Fees
A final factor to ponder when incorporating in Texas is the state's franchise tax.
Corporations and S corporations pay the greater of a 0.25% tax on "net taxable capital" or a 4.5% tax on something called "net taxable earned surplus."
LLCs should pay just the quarter-percent franchise tax on net taxable capital.
The net taxable capital for a corporation or LLC equals, essentially, the owners' equity in the business. While the net taxable earned surplus of a corporation equals the corporation's net taxable income plus the compensation paid to officers and directors if the corporation has 36 or more shareholders.
In summary, then, a Texas limited liability company may pay an annual quarter-percent franchise tax on its net worth. And corporations may pay a 4.5% tax on profits.
The Texas franchise tax rules, then, favor the Texas limited liability company option for very small businesses.
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